It is increasingly common to hear in boardrooms and webinars, to read in quarterly reports and specialized blogs, or when talking to a colleague, that ESG criteria form a core part of companies.
As these types of terms become commonplace, they tend to become meaningless. In other words, they are used without fully understanding their meaning: we may know what each acronym means without being able to see its implications.
Therefore, in this post we want to share in detail what these criteria are and how they work, how they are measured, and which are the areas they strengthen.
ESG is the acronym for Environmental, Social, and Governmental, a set of criteria that companies follow and investors look for to generate a portfolio that demonstrates their commitment to the environment, society and the responsible management of their assets.
In other words, it is the way in which companies and investors communicate to the public with concrete actions that seek to positively impact their environment, and that are not focused solely on generating profits.
Some investors have recently shown a growing interest in incorporating their values and beliefs in the type of investments they make, being guided by a holistic vision (combining business and economic, social and environmental aspects) when choosing where to allocate resources.
For their part, some established corporations have also opted to include ESG criteria in their development plans. Even startups and high-growth companies backed by investment funds have begun to make certain commitments to the sustainable growth agenda.
Now, it seems that when we try to define a "textbook" concept of ESG criteria, it evades us. The main reason is attributable to its plurality: there is too much variety in the three areas that comprise it to encapsulate them in a single definition.
Let us look at the environmental, social and governance aspects one by one, as well as the particular criteria that comprise them.
In general terms, the environmental criteria by which a company is evaluated include the use of renewable energies, its waste management program, the air or water pollution that its operations may cause, as well as its stance on climate change.
Other issues include the origin of their raw materials (whether they are organic or fair trade), or whether the land they own is biodiversity friendly.
This set describes a vast number of issues, from recruitment policies to organizational culture, and how they relate to the social framework to which they belong.
For the moment, let's stick to those that are much more likely to be evaluated and compared, as these will be the ones that investors will favor. Some of them are:
In the context of ESG criteria, governance refers to how top management runs the company they are in charge of. That is, how well - or poorly - top executives serve the different stakeholders in their business: employees, suppliers, shareholders, and customers, and also how they give back to the community.
Likewise, in financial and accounting terms, it is important that the operation is conducted with transparency. Board members and executives are obliged to act ethically and to avoid any conflict of interest that would be detrimental to the company's reputation.
One of the main reservations about ESG criteria was that there were no uniform criteria for measuring their impact. In response to this, the "Big Four" business consulting firms (PwC, KPMG, EY, and Deloitte) proposed a series of 22 criteria for measuring ESG at the 2020 World Economic Forum.
This series of parameters was called Stakeholder Capitalism and refers to a comprehensive perspective that allows companies to align their results with the progress of the Sustainable Development Goals proposed by the United Nations.
Although in this opportunity we will not review each one, it is worth mentioning that, to date, more than 120 companies and 70 international corporations subscribe to and use these indicators.
It is likely to be less complex today to answer why they would not be. Their importance is given both in their attributes and in their mission.
However, when they first emerged as a disruption in the business world, many stakeholders questioned their importance. Especially because, at the time, any such initiative was seen more as an expense than an investment - hence the skepticism, clearly.
As time went by, and as they gained a place in the mainstream, business growth plans began to be developed that positioned them as a viable strategy.
We identify two reasons that justify their adoption as part of a growth strategy.
Several studies show that companies with ESG metrics have a lower cost of capital, which gives them access to better financing, and also, that implementing this criteria can be linked to long term value. This is essential for both stimulating investment and improving companies' credit ratings.
As topics that directly impact these criteria (such as social equity or climate change) become more important to the public, the business world cannot be left behind.
Now that we have a bit more understanding of the reasons why ESG criteria are important for any company, let's look at some of the specific ways in which these criteria support growth.
Or in other words, how to move from theory to action.
So far we have seen that each of the areas that make up the ESG criteria has its own features. It remains to be seen how, when linked, they generate benefits for companies. This is regardless of their size or sector because one quality of these criteria is that good management ensures results for the overall well-being of the business.
A study published by McKinsey identifies the following:
A value proposition based on ESG criteria can make a company more appealing to other markets. When authorities have reason to trust a business's corporate performance, it is easier for them to grant permits, licenses, and approvals.
ESG criteria can also positively impact efforts to reduce a company's operating costs. That is because they create competitive advantages, such as in the cost of inputs and raw materials, or in energy consumption.
As a result of a company's good reputation for supporting ESG criteria, regulators and decision-makers at the government level may see its value proposition as a reason to relax certain provisions.
This is by no means to say that appropriate laws or regulations are not being followed, but when a company holds itself to a high standard of accountability and makes that information transparent, it can convince governments that the private sector is an ally not only for the economy but for the rest of the agenda.
Talent and the workforce can be powerfully attracted to a company's commitments and values, especially if they see that the company is truly committed to those causes.
Retaining talent and keeping it motivated is directly related to productivity, so maintaining a genuine interest in what drives employees is a win-win.
ESG can help strengthen the investment portfolio of a fund or private investor or boost a company's capital allocation.
Likewise, they can help prevent investments that do not have long-term sustainability plans (such as those that remain entirely dependent on fossil fuels, for example).
A good lesson ESG criteria teach us is that all good business starts from the ground up.
Those in charge of a company's overall strategy cannot overlook ESG criteria. This is not a passing fad, but a trend on which everyone is turning (not just the corporate world).
The data don't lie: companies that adopt these criteria are better positioned in the eyes of all their stakeholders - from the boardroom to coffee conversations.