What is ESG and Why Does It Matter?
In recent years, more businesses and investors have shown increased interest in following ESG criteria. Now, many are opting to prove transparency and ethics through financial interests. Environmental, Social, and Governance, is a framework used by companies to assess their impact on sustainability and social responsibility.
This approach helps businesses evaluate how their operations affect the environment, how they manage relationships with employees, customers, and communities, and how transparent their corporate governance is.
As a result, companies are now developing products that exclusively follow environmental, social, and governance criteria. With increasing interest in this criteria and newer generations of investors, many financial advisors have an ESG platform to cater to these criteria.
What is ESG?
ESG stands for environmental, social, and governance. Many investors use these three criteria to help identify risks and opportunities for growth for their company. This criteria help encourage responsible business practices.
Not every business strictly adheres to ESG criteria while performing financial reports. Recently, companies have begun implementing pieces of environmental, social, and governance in other annual or sustainability reports.
When a business states they follow environmental, social, and governance criteria, what does this mean? ESG-practicing companies declare they conduct ethical business practices in the three areas. Companies use various strategies and solutions to comply with environmental, social, and governance standards.
Types of Criterias
There are three different criterias: environmental, social, and governance. Responsibility in these three areas ensures steps toward holding companies accountable and ensuring best business practices.
Environmental
Environmental criteria focus on preserving the earth. Some standards businesses may follow in this category include energy use, waste levels, and treatment of animals. Adherence to these criteria also helps companies assess and evaluate possible environmental risks.
More examples of environmental criteria are:
- Climate change
- Air pollution
- Deforestation
- Carbon emission reduction
Social
Social criteria consider people and their relationships with one another. For many businesses, this means evaluating the company’s relationship with stakeholders.
Companies must hold their suppliers to higher standards and consider budgeting a percentage of profits to give back to the local community. These criteria also encourage safe, healthy, and productive workplace conditions.
More examples include:
- Gender inclusion
- Diversity
- Mental health
- Community relations
Governance
Governance criteria focus on the logistics of operating a business. Adhering to these criteria means companies are transparent about finances and select ethical individuals for leadership positions.
More examples of governance include:
- Hiring and onboarding practices
- Political contributions
- Board of directors
- Executive compensation
Criteria: pros and cons
The idea of criteria is appealing, but it is not for everyone.
Even if you invest in a well-performing fund or two, omitting certain companies or categories from your portfolio can impact your result.
For example, the tobacco industry is known to produce large financial returns. However, those following criteria could never invest in the tobacco industry making them lose out on crucial investments.
Many companies also have a different definition of social responsibility, and with an effective marketing campaign, anything is believable.
Conclusion
Ultimately, the true value of ESG criteria shines when businesses commit to using the guidelines to strive for actual change through their investment choices.
As newer generations of investors continue to put pressure on companies to do more than just check boxes under the criteria, more companies will shape up into ethical ones in the near future.
