Environmental, Social and Governance Criteria or ESG is a financial umbrella term. It concerns ratings and standards that investors set and take into account for evaluating and assessing a business’s operations towards sustainability and ethics. More specifically, the environmental criteria assess how businesses operate considering its impact on nature. The social criteria audit the intra and outer corporational management, meaning how a business treats its employees and stakeholders. Finally, the Governance criteria deals with internal controls, auditing, leadership matters and shareholder rights. The ESG principles are imperative in order for investors to decide whether a company is worth investing in.
What is the difference with traditional investing?
ESG separates itself from common investing and auditing with the integration of one important word: responsibility. That is why ESG is not commonly part of a financial analysis, however it has financial relevance. Responsible investing means taking into account how businesses work with and for the environment for sensitive matters such as global warming, plastic pollution etc. Furthermore, it measures how businesses operate in terms of employee health and safety matters, if they integrate a corporate culture of innovation and trust, and also how sustainable and ethical the supply chain is managed. Investors leveraging ESG standards in their assessment have an advantage on sustainable ways to invest whilst preserving the same level of financial returns as in standard investment practices.
The history of ESG
In 2004, Kofi Annan, the UN Secretary General, bound 50 CEOs of major financial institutions around the world to join an initiative of the UN Global Compact under the support of the International Finance Corporation and Swiss Government. The purpose was to leverage ways to start integrating environmental and social corporate concerns into capital markets. A year later, Annan’s initiative brought the “Who Cares Wins” report into corporate light. This report is considered the onset of ESG criteria and argued that if capital markets and businesses aim at better and more sustainable outcomes for society and the environment, they ought to integrate environmental, social and governance standards. At the same time, the release of the “Freshfield Report” from UNEP Financial Initiative established that ESG is relevant for financial matters and valuation as well.
Between 2011 and 2019, ESG developed from a niche concern to a corporate prerequisite when more than 500 firms that reported their ESG ratings surged from 20% to 90% according to G&A Institute.
The current rise on demand on ESG ratings
In recent years, ESG developed into a big business since it is essential for investors to understand a company’s corporate purposes, strategies and quality management.
Especially for the fashion industry. It needs to meet consumers’ sustainable demands or sacrifice profitability. ESG scores bring a great degree of transparency especially for high-end brands where it is way harder to apply ratings and assessments across their whole supply chain.
However, specialists argue that there are currently many brands that modify the ratings or simply provide only favorable information that are often misleading to the ESG investors. One issue on this is that ESG rating does not have a universal supervising system. Not all ESG ratings are created equally and some indices lack information from the brands. This is partially because of the fact that ESG key performance indicators vary from country to country, hence it is hard to provide a global assessment without taking into account each country’s standards.
Another drawback is that ESG is based on past data and thus on evaluations of a brand at a certain point in time rather than a continuous one. Especially for fashion brands and their sustainable performance over time, investors cannot stand on just a score -not even as a point of comparison.
Despite the limitations, many fashion brands started increasing the demand for a substantial ESG scoring and are making efforts for better results. Hugo Boss leverages ESG ratings as an objective assessment tool to quantify its progress over time, compare its performance with competitors and identify areas of improvement in a way that is visible to as many stakeholders as possible. Burberry uses ESG to drive accountability, to gain information on a strategy level and on continuous sustainable improvements.