What is ESG?

There may be no hotter topic right now in the investment, business, and political world than ESG – the acronym which stands for environmental, social, and governance.

ESG is a framework used by investors and companies to evaluate the sustainability and ethical impact of an investment or business decision.

“ESG really went mainstream when the framework became an integral part of many institutional investors’ playbooks. There are a growing number of ESG rating agencies that assign ESG scores, as well as new and evolving reporting frameworks, all of which are improving the transparency and consistency of the ESG information that firms are reporting publicly (often called ESG disclosure),” explains the Corporate Financial Institute (CFI).

ESG is in the News Today … In a Big Way

While topics such as socially responsible investing (SRI) and environmental, health, and safety (EHS) emerged in the 1960s, 1970s, and 1980s, ESG is a fairly new player but currently, a Google search returns 469 million results for “ESG”, and a Google News search returns a whopping 37 million results.

And those numbers are likely to only go up as ESG is primed to be a talking point in the next presidential election.

Regardless of one’s thoughts of where ESG falls on the political spectrum, there is no denying that it has become a key consideration for investors, with many investment firms incorporating ESG factors into their investment decision-making process.

In addition, many companies, such as those in the manufacturing sector, have adopted ESG policies and practices to respond to growing investor and consumer demand for sustainable and socially responsible investments.

The History and Evolution of ESG

The concept of ESG has been around for several decades, but it has gained more prominence in recent years due to growing concerns about sustainability and social responsibility.

The origins of ESG can be traced back to the 1960s and 1970s when socially responsible investing (SRI) began to emerge.

SRI involves selecting investments based on both financial performance and social or environmental criteria. In the 1980s, SRI expanded to include a focus on corporate governance, which became known as socially responsible governance (SRG).

At the same time, environmental, health, and safety (EHS) was evolving in the 1990s into the “corporate sustainability” movement. By the early 2000s, the corporate sustainability movement became known as corporate social responsibility (CSR).

The seeds of today’s ESG were planted in January 2004 when former United Nations Secretary-General Kofi Annan invited over 50 CEOs of major financial institutions to participate in a joint initiative with the UN Global Compact, the International Finance Corporation (IFC), and the Swiss government.

“The goal of the initiative was to find ways to integrate ESG into capital markets. A year later this initiative produced a report entitled “Who Cares Wins,” with Ivo Knoepfel as the author,” reports Georg Kell in Forbes. “The report made the case that embedding environmental, social and governance factors in capital markets makes good business sense and leads to more sustainable markets and better outcomes for societies.”

Kell says that at the same time, the UNEP Finance Initiative produced the “Freshfield Report” that showed that ESG issues are relevant for financial valuation.

The “Who Cares Wins” and “Freshfield Report” formed the nucleus for the launch of the Principles for Responsible Investment (PRI) at the New York Stock Exchange in 2006 and the launch of the Sustainable Stock Exchange Initiative (SSEI) the following year.

Defining the Basics of ESG

ESG is the intersection of its three core principles: environmental, social, and governance.

ESG factors can be important because there is potential for a significant impact on the long-term performance and reputation of a company.

Many investors now incorporate ESG considerations into their investment decision-making process, and many companies have adopted ESG policies and practices in response to growing investor and consumer demand for sustainable and socially responsible investments.

The basics of the three ESG areas include:

• Environmental (E): The “E” refers to the impact of a company’s activities on the natural environment, including climate change, pollution, and resource depletion.

“Environmental factors refer to an organization’s environmental impact(s) and risk management practices. These include direct and indirect greenhouse gas emissions, management’s stewardship over natural resources, and the firm’s overall resiliency against physical climate risks (like climate change, flooding, and fires),” says CFI.

• Social (S): The “S” refers to the impact of a company on society, including labor practices, human rights, and community engagement. The “S” focuses on a company’s relationships with stakeholders.

“A hallmark of ESG is how social impact expectations have extended outside the walls of the company and to supply chain partners, particularly those in developing economies where environmental and labor standards may be less robust,” says CFI.

• Governance (G): The “G” refers to the way a company is managed, including board structure, executive compensation, and shareholder rights.

“ESG analysts will seek to understand better how leadership’s incentives are aligned with stakeholder expectations, how shareholder rights are viewed and honored, and what types of internal controls exist to promote transparency and accountability on the part of leadership,” says CFI.

“ESG factors cover a wide spectrum of issues that traditionally are not part of financial analysis yet may have financial relevance,” writes Kell. “This might include how corporations respond to climate change, how good they are with water management, how effective their health and safety policies are in the protection against accidents, how they manage their supply chains, how they treat their workers, and whether they have a corporate culture that builds trust and fosters innovation.

The Role of ESG in the Manufacturing Sector

ESG factors are especially relevant to the manufacturing sector, given the sector's significant impact on the environment and society.

Environmental considerations for manufacturing companies may include:

• Energy and resource use: Manufacturing companies need to evaluate and optimize their energy and resource usage, such as water, electricity, and raw materials, to reduce their environmental impact.
  
  
• Pollution and emissions: Manufacturing companies need to minimize the release of pollutants and greenhouse gas emissions, such as carbon dioxide, methane, and volatile organic compounds (VOCs), into the environment.
  
  
• Waste management: Manufacturing companies need to manage waste responsibly, such as hazardous waste, electronic waste, and industrial waste, and find ways to recycle or reuse materials.

Social considerations for manufacturing companies may include:

• Labor practices: Manufacturing companies need to ensure fair labor practices, such as safe working conditions, fair wages, and non-discriminatory employment practices.
  
  
• Supply chain management: Manufacturing companies need to ensure that their suppliers follow ethical and sustainable practices, such as avoiding child labor, protecting human rights, and reducing environmental impact.
  
  
• Community engagement: Manufacturing companies need to engage with local communities to understand their needs and concerns and implement practices that benefit the community.

Governance considerations for manufacturing companies may include:

• Board structure: Manufacturing companies need to ensure that their board of directors is diverse and has the necessary skills and experience to manage the company effectively.
  
  
• Executive compensation: Manufacturing companies need to align executive compensation with long-term performance and ESG objectives.
  
  
• Shareholder rights: Manufacturing companies need to respect shareholder rights, such as the right to vote on important decisions and access to information.

Acronyms will surely come and go in the coming years, but manufacturing companies will always need to account for environmental, social, and governance considerations in their operations, supply chain, and governance practices to ensure long-term sustainability and success.