What is ESG?

The issue of sustainability has gained fame recently. The scope of the issue also expands, mentioning not only the planet’s well-being but also the well-being of the people and peace. While in the past, responsibility for achieving sustainability rested solely on government bodies, today private companies are also responsible for implementing sustainability practices. Forced by consumers’ and investors’ growing value towards sustainability, private companies have allocated their resources to foster their efforts to capture non-financial risks and opportunities from their daily operations. In order to attain that objective, the ESG framework is developed.

The ESG framework takes into account the environmental, social, and governance aspects of an organization’s operations. The framework provides a comprehensive approach to sustainable business practices by focusing on these three key areas. This framework has experienced significant development in recent years. Progress has been driven by the evolution of reporting standards and frameworks and voluntary cooperation from companies, leading to a better comprehension of financially significant ESG information. As progress continues, ESG investing is simultaneously becoming more sophisticated. This advancement reflects a growing emphasis on ethical and sustainable investment practices, which will lead to sustainable returns and a sustainable future.

Incorporating ESG into Investment Decisions

ESG Investing signifies a paradigm shift from traditional investing. It distinguishes itself from conventional investing by considering environmental, social, and governance aspects in the investment decision-making process. Unlike traditional investing, which solely concentrates on financial returns, ESG investing considers the broader effects of companies on society and the environment. The difference also lies in risk management, where traditional risk management revolves around financial metrics, such as credit risk and market volatility. However, ESG risk management takes into account non-financial risks, such as environmental impact and social responsibility, as well as financial risk. In short, ESG investing acknowledges that non-financial factors can profoundly impact a company’s performance, long-term sustainability, resilience, and value creation.

Understanding the meaning of ESG is essential when incorporating it into investment decisions. The environmental pillar of ESG focuses on how a company manages natural resources and the consequences its activities have on the environment, encompassing both its immediate operations and its entire supply chain. Investors reflect on companies’ land use, water management, carbon prints, and other relevant environmental metrics. When considering the social pillar, investors may take into account the social factors that could arise in the interactions between a company and individuals or institutions external to the company. This can be observed through employee development management and company labor practices. Lastly, the governance pillar can be assessed through the corporation’s behavior and patterns, such as board diversity, corruption, and competition practices.

Over the years, incorporating ESG into investment decisions has shown a growing trend, shifting investors to ESG investing. According to the GSIA Report, sustainable investing assets reached $30.3 billion in 2022 worldwide, with Europe almost occupying 50% of the pie (Figure 1). Research shows that companies’ disclosure of ESG information also positively affects ESG investing trends. According to the ESG Disclosure Prevalence, 63.9% of companies disclosed their ESG policies in 2022, up from only 6.3% in 2018. These disclosures are essential for ESG investors to push their investment decisions. As mentioned in EY’s Global Reporting Report, 99% of surveyed investors utilize the disclosed ESG information and 74% use advanced methods. In short, both companies and investors show growing interest in expanding their ESG investing efforts.

How Sustainable Is the Benefit?

Companies and investors are said to show growing trends in their ESG investing efforts. This raises the question of how much benefit they expect from their efforts. However, as mentioned before, ESG investing captures the financial metrics in the investment process and non-financial factors, such as environmental impact, social responsibility, and governance practice. Thus, considering those non-financial factors is essential to determine the benefit of ESG investing for companies and investors.

Adopting ESG alignment will undoubtedly benefit companies’ brands. This adoption could include ESG information disclosure, sustainability report publishing, and ecolabel adoption. The primary benefit is that it attracts more investors to invest in the company. Companies that align with ESG principles can also receive more funding from financial institutions to support their sustainable business processes, which typically involve expensive machinery and tools. Additionally, these companies can expand their funding sources using sustainable financing instruments such as green and social bonds.

ESG investors distinguish themselves from conventional investors by considering environmental, social, and governance aspects in the investment decision-making process. These considerations imply that the benefit they expect is beyond the financial return, that is, the impacts on ESG that align with their values. First, the investments they make directly support companies’ sustainable business processes. This could reduce companies’ carbon emissions, lower environmental harm, push ethical labor practices, and more transparent corporate processes. Next, with growing ESG investing trends, this kind of support expands, and the sustainable business process delivers a larger scale of impact. These massive impacts, in return, provide benefits for the investors themselves, such as fresher air to breathe and a cleaner environment. However, the biggest benefit the ESG investors gained is the decision to do the right thing that aligns with their values.

Reference: 

Aich, S., Thakur, A., Nanda, D., Tripathy, S. and Kim, H.-C. (2021). Factors Affecting ESG towards Impact on Investment: A Structural Approach. Sustainability, 13(19), p.10868. doi:https://doi.org/10.3390/su131910868  

Cifrino, D. (2023). The Rise of International ESG Disclosure Standards. [online] The Harvard Law School Forum on Corporate Governance. Available at: https://corpgov.law.harvard.edu/2023/06/29/the-rise-of-international-esg-disclosure-standards/ 

EY (2022). How can corporate reporting bridge the ESG trust gap? [online] EY. Available at: https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/assurance/assurance-pdfs/ey-global-reporting-survey-report-2022.pdf 

Global Sustainable Investment Alliance (2023). Global Sustainable Investment Review 2022. [online] Available at: https://www.gsi-alliance.org/wp-content/uploads/2023/12/GSIA-Report-2022.pdf 

S&P Global (2020). What Is the Difference between ESG Investing and Socially Responsible investing? [online] www.spglobal.com. Available at: https://www.spglobal.com/en/research-insights/articles/what-is-the-difference-between-esg-investing-and-socially-responsible-investing 

Wen, H., Gao, J., Yu, L. and Ho, K.C. (2022). The Fundamental Effects of ESG Disclosure Quality in Boosting the Growth of ESG Investing. Journal of International Financial Markets, Institutions and Money, 81(101655), p.101655. doi:https://doi.org/10.1016/j.intfin.2022.101655