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ESG investing has proven to be one of the most durable investment trends over the past decade. Learn why all kinds of investors support ESG funds and investments.
ESG / CSR
2022-09-29T00:00:00.000Z
2024-12-30T00:00:00.000Z
en-us
ESG investing is reshaping the investment landscape. Once, financial returns were the sole focus of investment decisions. Now, ESG investing prioritizes strategies that deliver both financial performance and positive societal impact, reflecting a growing demand for more responsible and sustainable investment practices.
👉 What exactly is ESG investing? Why has it gained so much momentum? And what makes it such a compelling choice for investors today?
What is ESG investing?
ESG investing refers to an investment strategy that incorporates environmental, social, and governance factors into decision-making processes. This approach assesses a company's environmental impact, its treatment of employees and communities, and the strength of its leadership and ethics. By doing so, ESG investing allows investors to align their financial goals with their values while identifying companies poised for long-term sustainability.
The term "ESG" refers to environmental, social, and governance performance - key factors that, alongside profitability, reflect a company’s overall impact on society. ESG investing recognizes that businesses must balance these diverse priorities to ensure long-term sustainability and success.
By incorporating ESG factors into their decision-making, investors go beyond traditional financial analysis. They assess a company’s environmental footprint, social responsibility, and governance practices, enabling them to align investments with their personal or organizational values while contributing to meaningful societal change.
“ This approach has fundamentally redefined what success means in the investment world. Financial returns are no longer the sole measure of a company’s worth. Instead, ESG investing emphasizes that businesses excelling in environmental stewardship, social impact, and governance are better positioned for sustainable, long-term growth. ”
The rise of ESG investing has also driven greater corporate transparency and accountability. To attract ESG-conscious investors, companies are increasingly disclosing detailed information about their environmental impact, social initiatives, and governance structures. This heightened transparency builds trust, encourages responsible practices, and strengthens the relationship between investors and the companies they support.
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ESG in more detail
ESG investing goes beyond traditional, profit-driven strategies by placing equal emphasis on environmental, social, and governance factors. It highlights the material risks and opportunities associated with these areas, recognizing that they are integral to a company’s long-term success and resilience.
Often used interchangeably with terms like sustainable investing, impact investing, socially responsible investing, and ethical investing, ESG investing reflects a shared commitment to sustainable development and responsible business practices. These approaches collectively fall under the broader umbrella of responsible investment, helping investors drive meaningful change while pursuing competitive financial returns.
Unlike short-term profit-focused approaches that often harm the environment or society, ESG investing prioritizes long-term value creation. The aim is to help businesses thrive while safeguarding the natural resources and human capital they depend on.
👉 Well-known ESG frameworks include CDP, the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD). These frameworks provide guidelines for measuring and reporting ESG performance, while annual corporate social responsibility (CSR) reports help investors compare businesses on key metrics.
To evaluate companies, ESG investors often rely on indices such as the Dow Jones Sustainability Index (DJSI), Morgan Stanley Capital International (MSCI), FTSE4Good, and ISS ESG Solutions, which aggregate and analyze ESG ratings.
Investors can also disclose their own sustainability efforts by aligning with the United Nations’ Principles for Responsible Investing (PRI), introduced in 2006. With over 2,000 signatories worldwide, the PRI offers a recognized set of ethical investment guidelines.
Relevant ESG frameworks:
Framework
Focus
Relevance
CDP
Climate change, water security, deforestation
Helps companies disclose environmental data and track progress
SASB
Industry-specific ESG standards
Provides sector-based benchmarks for sustainability performance
GRI
Broad ESG reporting
Encourages transparency across all ESG factors, widely adopted globally
TCFD
Climate-related financial disclosures
Assists companies in aligning with climate-related risk and opportunity reporting
Mandatory ESG reporting
The rise of mandatory ESG reporting reflects a global shift towards greater transparency and accountability in financial markets. These regulations aim to ensure that companies disclose the environmental, social, and governance factors influencing their operations. Sustainable funds depend on this transparency to assess the ESG credentials of their investments and maintain credibility with stakeholders.
UK companies obligated to produce a non-financial information statement, including those with over 500 employees, listed on a UK-regulated market or operating as banking or insurance companies (Relevant Public Interest Entities).
UK-registered companies listed on the London Stock Exchange with over 500 employees.
UK-registered companies not falling into the above categories but with over 500 employees and a turnover exceeding £500 million.
Large Limited Liability Partnerships (LLPs) without trading or banking activities, with over 500 employees and a turnover exceeding £500 million.
Traded or banking LLPs with over 500 employees.
These regulations extend beyond major companies and financial institutions to include numerous businesses within their supply chains, emphasizing the importance of initiating ESG reporting regardless of direct impact.
In 2024, the UK government published an implementation update on Sustainability Disclosure Requirements (SDR), outlining plans to build on global best practices and leading standards to support the UK's ambition to become the world's first Net Zero Aligned Financial Centre.
EU
The Non-Financial Reporting Directive (NFRD) previously required approximately 11,000 large companies in the EU to disclose ESG information. In January 2023, the Corporate Sustainability Reporting Directive (CSRD) replaced the NFRD, expanding the scope to around 50,000 companies, accounting for approximately 75% of the total turnover of EU companies. The CSRD modernizes and strengthens the rules concerning the social and environmental information that companies must report.
The CSRD entered into force on January 5, 2023, with the first set of companies required to start reporting in 2025 for the financial year 2024. The directive applies to a broader set of large companies and listed SMEs, ensuring that companies identify and address adverse human rights and environmental impacts of their actions inside and outside Europe.
US
As of December 2024, the United States has made significant strides toward mandatory ESG disclosures at the federal level. In March 2024, the Securities and Exchange Commission (SEC) adopted rules to enhance and standardize climate-related disclosures for investors. These rules require registrants to provide certain climate-related information in their registration statements and annual reports, including information about climate-related risks that are reasonably likely to have a material impact on their business, results of operations, or financial condition.
The final rules will become effective 60 days after publication in the Federal Register, with compliance dates staggered based on the registrant's filer status. However, the implementation of these rules may face challenges due to potential changes in SEC leadership and differing political priorities.
Why is ESG analysis becoming important to companies?
ESG investing has seen explosive growth, rising by an astounding 456% between 2005 and 2020. This surge reflects the increasing desire among individuals, institutional investors, asset managers, and organizations to align their investments with values that drive both financial returns and positive societal change. The growing awareness of ESG risks, such as regulatory penalties, reputational damage, and environmental liabilities, has further encouraged this shift toward sustainable investment strategies.
Contrary to the belief that profitability must come at the expense of environmental or social responsibility, studies have consistently shown a strong link between ESG investment performance and financial growth. For example, a Fidelity study analyzing global ESG investments from 1970 to 2014 revealed that half outperformed the broader market, while only 11% underperformed.
Further supporting this trend, Morningstar’s research found that ESG funds are more stable and deliver positive returns. Over a ten-year period, 77% of ESG funds remained active, compared to just 46% of conventional funds, highlighting the resilience and longevity of ESG-focused investments.
The benefits and importance of ESG analysis:
Benefit/Importance
Explanation
Improves financial performance
ESG-focused companies are more likely to deliver long-term, sustainable growth and profitability.
Reduces risk
Identifies and mitigates risks related to environmental, social, and governance factors.
Enhances reputation
Positions companies as ethical and sustainable, strengthening brand trust and loyalty.
Attracts investors
ESG analysis appeals to socially conscious investors, opening access to a broader investor base.
Drives consumer preference
Consumers are more likely to support brands that prioritise ESG principles.
Encourages cost efficiency
Implementing ESG initiatives can lead to reduced operational costs and improved efficiency.
Fosters regulatory compliance
Ensures adherence to growing global ESG reporting requirements, avoiding penalties.
Supports employee engagement
Companies with strong ESG values attract and retain top talent who value ethical workplaces.
Encourages innovation
Drives creative solutions to address sustainability challenges and future-proof businesses.
Promotes stakeholder trust
Transparent ESG practices strengthen relationships with stakeholders, including customers, employees, and investors.
Enables access to capital
ESG-focused companies are often favoured by lenders and investors, improving financing options.
Aligns with global trends
Positions companies to adapt to increasing demand for sustainable and ethical practices globally.
What are the ESG criteria?
In voluntary ESG reporting, businesses have traditionally disclosed performance metrics based on issues relevant to their operations. Various ESG frameworks recommend reporting on specific factors such as greenhouse gas (GHG) emissions.
However, not all factors fit neatly into the categories of "E" (environmental), "S" (social), or "G" (governance), as many have interconnected impacts. For example, reducing GHG emissions directly addresses environmental concerns like climate change, but it also improves community health, which is a social consideration.
In addition to tracking these factors, businesses are increasingly expected to evaluate the financial risks and opportunities tied to ESG issues. Quantifying ESG factors in financial terms can be challenging, and ensuring the accuracy of these measurements often requires expert guidance.
Collaborating with organizations that specialise in ESG quantification helps businesses accurately measure and report on these critical factors, ensuring they meet expectations and demonstrate accountability.
ESG factors:
Category
Factor
Explanation
Environmental
Greenhouse gas (GHG) emissions
Tracks the company’s contribution to global warming and climate change.
Environmental
Energy efficiency
Measures how effectively energy is utilised to reduce consumption and costs.
Environmental
Water consumption
Assesses water use to minimise depletion of this critical resource.
Environmental
Toxic substances and pollution
Tracks the release of harmful chemicals and pollutants into the environment.
Environmental
Biodiversity loss and protection
Evaluates the impact on ecosystems and efforts to preserve biodiversity.
Environmental
Deforestation
Examines activities contributing to forest loss and measures to protect natural habitats.
Environmental
Waste management
Assesses how waste is minimised, reused, or responsibly disposed of.
Environmental
Product life cycle analysis
Reviews the environmental impact of a product from production to disposal.
Social
Human rights and child labour
Ensures ethical practices across operations and supply chains.
Social
Living wages
Evaluates whether workers are paid wages that meet basic living standards.
Social
Worker health and safety
Assesses measures to protect employee health and safety.
Social
Diversity, equity, and inclusion
Measures efforts to create equitable workplaces and promote diversity.
Social
Data protection and privacy
Tracks policies to safeguard personal and organisational data.
Social
Employee and customer satisfaction
Evaluates how well employees and customers are engaged and satisfied.
Social
Community relations
Measures the company’s impact on and relationship with local communities.
Social
Stakeholder engagement
Tracks efforts to involve and communicate with key stakeholders.
Governance
Board composition
Evaluates diversity, expertise, and independence of board members.
Governance
Executive compensation
Assesses alignment between executive pay and company performance.
Governance
Tax strategy
Measures transparency and fairness in tax practices.
Governance
Bribery and corruption
Tracks policies and measures to prevent unethical practices.
Governance
Lobbying and political contributions
Evaluates transparency and alignment of political activities with company values.
Governance
Transparency and public disclosures
Measures how openly the company communicates its ESG practices.
Governance
Codes of conduct
Reviews adherence to ethical standards and corporate policies.
Governance
Supply chain management
Tracks efforts to ensure ethical and sustainable practices across the supply chain.
Governance
Risk and crisis management
Assesses how prepared the company is to handle risks and crises effectively.
Are there specific metrics to consider?
While there is no universal standard for ESG reporting, certain metrics are consistently highlighted due to their relevance across industries. These metrics typically address environmental, social, and governance factors in ways that reflect material risks and opportunities for a company’s operations and stakeholders.
Key environmental metrics often include greenhouse gas (GHG) emissions, energy efficiency, and water usage. For example, measuring GHG emissions has become increasingly central to ESG reporting due to global climate targets such as the Paris Agreement. Companies may quantify emissions either as absolute emissions (total emissions over a set period) or emissions intensity (emissions relative to units of output or profit). While absolute figures are crucial for tracking global climate goals, intensity metrics are valuable for assessing performance as businesses grow.
Social metrics vary widely depending on the company’s sector and scope. Common areas include workforce diversity, equity, and inclusion (DEI); employee health and safety; and data protection and privacy. For example, companies in tech may focus heavily on cybersecurity practices, while manufacturing firms often prioritize workplace safety indicators.
Governance metrics are typically centered around board diversity, executive compensation, and risk management frameworks. Transparency is key - companies are expected to disclose tax strategies, anti-corruption efforts, and political contributions to demonstrate ethical governance practices.
A move toward standardization
Historically, ESG metrics have been voluntary and chosen based on relevance to a company’s industry. However, the regulatory landscape is changing. Recent developments include:
The ISSB Standards (IFRS S1 and IFRS S2), introduced in 2023, consolidate previous frameworks like the Task Force on Climate-related Financial Disclosures (TCFD). These standards provide a global baseline for sustainability reporting, ensuring consistency across markets.
The EU’s Corporate Sustainability Reporting Directive (CSRD), will require certain companies to adopt European Sustainability Reporting Standards (ESRS) starting from 2025.
The UK’s Sustainability Disclosure Requirements (SDR), align closely with ISSB standards and mandate reporting on climate-related financial risks.
These frameworks aim to simplify ESG reporting by offering clear, comparable metrics across jurisdictions, helping companies respond to stakeholder demands and comply with legal obligations.
Challenges in metric selection
Choosing the right metrics often depends on a company’s ability to accurately measure and verify performance. Environmental metrics like GHG emissions often require advanced tracking tools and external verification, while social and governance metrics may be harder to quantify. For example, assessing the impact of stakeholder engagement or workplace culture may require a mix of qualitative and quantitative data.
Ultimately, selecting metrics should be guided by materiality - focusing on the issues that have the most significant impact on the company’s value creation and stakeholder interests.
ESG labelling regulations
ESG labeling regulations continue to evolve globally, focusing on improving transparency, enabling easier comparison of ESG funds, and addressing the growing issue of greenwashing. These frameworks aim to help investors make informed decisions by providing clear and consistent criteria for assessing sustainability credentials.
United Kingdom
The UK has recently introduced the Sustainability Disclosure Requirements (SDR), which standardizes ESG disclosures and establishes a clear labeling system for investment funds. Key components include:
Anti-greenwashing rule: All FCA-authorised firms must ensure sustainability-related claims are accurate, clear, and not misleading. This rule came into effect in mid-2024.
Sustainability labels: Investment funds are now categorized into three labels:
Sustainable focus: Funds that invest at least 70% in assets with robust sustainability credentials.
Sustainable improvers: Funds aiming to improve ESG performance over time, with measurable progress required.
Sustainable Impact: Funds addressing specific environmental or social challenges, with clear objectives tied to measurable outcomes.
To ensure a smooth transition, firms have until April 2025 to fully comply with these labeling and disclosure rules (FCA).
European Union
The EU’s Sustainable Finance Disclosure Regulation (SFDR) remains a cornerstone of ESG labeling in Europe, with its three-tier fund classification system:
Article 6 funds: Do not integrate sustainability into their investment processes.
Article 8 funds: Promote environmental or social characteristics but are not primarily focused on sustainability.
Article 9 funds: Have sustainability as their core investment objective.
Recent updates include:
Stricter naming rules: Funds using terms like "green" or "sustainable" must meet stricter criteria to avoid misleading investors. Exemptions are allowed for green bonds from high-emission issuers under specific conditions.
Proposed simplifications: Advisers have suggested replacing the current classifications with three categories - "Sustainable," "Transition," and "ESG Collection" - to improve clarity for investors and reduce confusion.
United States
The US Securities and Exchange Commission (SEC) has advanced its efforts to strengthen ESG labeling and reporting requirements:
Fund classifications:
ESG-integrated funds: Incorporate ESG factors as part of broader investment considerations, with detailed methodology disclosures.
ESG-focused funds: ESG factors play a significant role, requiring detailed emissions disclosures and standardized asset selection criteria.
Impact-focused funds: Funds designed to achieve specific ESG outcomes, with transparent measurement of qualitative and quantitative progress.
80% rule: Funds with ESG in their name must allocate at least 80% of their assets to align with the stated ESG focus.
The SEC also finalized climate disclosure rules in early 2024, requiring public companies to disclose climate risks and emissions data. However, Scope 3 emissions reporting remains voluntary for most companies.
What are the main trends in ESG?
Environmental, Social, and Governance (ESG) considerations have become integral to business strategies, reflecting a global shift towards sustainable and responsible practices. Several key trends are shaping the ESG landscape:
Climate change mitigation and adaptation
The urgency to address climate change continues to drive corporate strategies. Companies are setting ambitious net-zero targets and investing in renewable energy to reduce greenhouse gas emissions. The 2015 Paris Agreement has been a catalyst, with nations and corporations committing to limit global warming. Public opinion also supports climate action; for instance, a Yale poll indicates that a significant majority of Americans believe CO₂ should be regulated and that corporations should do more to address global warming. Investors are increasingly evaluating businesses based on their climate resilience and carbon footprint, making climate-related disclosures a priority.
Enhanced ESG reporting and regulatory scrutiny
Regulatory bodies worldwide are implementing stringent ESG reporting requirements to combat greenwashing and ensure transparency. In the European Union, the Sustainable Finance Disclosure Regulation (SFDR) categorizes funds to help investors understand their sustainability focus. Similarly, the U.S. Securities and Exchange Commission (SEC) has proposed amendments to enhance ESG disclosures among funds. These regulations aim to standardize ESG metrics, enabling investors to make informed decisions.
Social equity and workforce well-being
The COVID-19 pandemic and subsequent economic challenges have highlighted social inequalities, prompting companies to prioritize diversity, equity, and inclusion (DEI) initiatives. Employee mental health and well-being have become focal points, with businesses implementing flexible work arrangements and support systems. Addressing social issues is now seen as essential for maintaining employee morale, enhancing productivity, and safeguarding corporate reputation.
Rise of sustainable finance and investment
Sustainable investing is experiencing significant growth, with ESG assets projected to reach substantial figures in the coming years. Investors are increasingly allocating capital to companies demonstrating strong ESG performance, recognizing the long-term value and risk mitigation these practices offer. This trend is reshaping capital markets, encouraging businesses to adopt sustainable practices to attract investment.
Integration of Artificial Intelligence (AI) in ESG strategies
Artificial Intelligence is playing a pivotal role in enhancing ESG initiatives. AI aids in data analysis for ESG reporting, monitors supply chain sustainability, and assesses environmental impacts. However, the ethical use of AI itself has become an ESG consideration, with stakeholders scrutinizing how companies deploy AI technologies responsibly.
Focus on biodiversity and natural capital
Beyond climate change, there is a growing emphasis on preserving biodiversity and managing natural resources sustainably. Companies are assessing their impacts on ecosystems and incorporating biodiversity considerations into their ESG strategies. This holistic approach acknowledges the interconnectedness of environmental factors and aims to promote overall ecological balance.
💡 These trends underscore the evolving nature of ESG considerations, highlighting the increasing importance of sustainability in corporate governance and investment decisions.
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