Introduction. What is ESG
Now gaining popularity all over the world the abbreviation ESG, large corporations are initiating entire strategies to comply with this direction. But what is ESG, and what benefits should it bring to business? In short, this is minimizing risks and developing business using a systematic approach.
And if this topic is interesting to you, then in this article we will give you basic information so that you understand how it works and can begin the path in this direction consciously.
ESG stands for “environmental, social and corporate governance.” In a global sense - sustainable development of commercial activities, which is based on the following principles:
responsible attitude towards the environment (English, E - environment);
high social responsibility (English, S - social);
high quality of corporate governance (English, G - governance).
In addition to this part, we recommend reading the article at the link
Well, visualization of the concept below
ESG criteria
Now we propose to take a closer look at the ESG criteria
The E-sector (environmental principles) determines how much a company cares about the environment and how it tries to reduce the damage caused to the environment in the course of its activities:
- the company’s impact on the planet’s climate and global warming (carbon emissions into the atmosphere)
- use of natural resources (pollution of water sources, negative impact on flora and fauna)
- environmental pollution (toxic and radiation waste, use of chemically harmful packaging for products)
- use of “green” technologies (energy from renewable sources, restoration of the company’s territory of operation
S-sector – (social principles) shows the company’s attitude towards staff, suppliers, clients, partners and consumers. To meet the standards, a business must work on the quality of working conditions , monitor gender balance or invest in social projects:
- attitude towards personnel (occupational safety, health, career opportunities, working conditions)
- responsibility in the production of products (product quality, data security, reliability, responsible investment)
- social benefits (ensuring staff communication, financial assistance programs, additional employee health insurance, food provision)
For example, the American outerwear brand Patagonia does not own the factories that make its products, so it cannot influence the wages of workers. To correct this, as part of the Fair Trade program, the brand directs part of the funds from product sales to factories to raise employee salaries to the living wage.
The G-sector (management principles) affects the quality of company management: transparency of reporting, management salaries, a healthy environment in offices, relations with shareholders, anti-corruption measures
- company management (composition of the board of directors, internal audit, openness of the company to shareholders)
- the company’s line of conduct (corporate ethics, tax transparency, absence of corruption, fair competition in the market)
Types and features of methodology
We looked and saw how wonderful everything was, like a new trend for everything good and against everything bad. But how does it all work? And this is where the pitfalls begin.
ESG has historically emerged as an extension of the published reporting of public companies - in addition to financial reporting, regulators have gradually made it mandatory to also publish “non-financial reporting”, which is now called ESG reporting or CSR reporting (corporate social responsibility). And now ESG is primarily relevant for companies that publish their reports and whose shares or bonds are traded on exchanges.
Typically, an individual company's ESG profile relates to:
ESG ratings from specialized agencies
It is assigned to a specific company from a specific agency (like a credit rating) and affects the investment attractiveness of its shares and debt instruments, as well as the ability to participate in “green financing” programs.
ESG reporting or “non-financial reporting” of a company
On its basis, investors and analysts evaluate the ESG components of a company’s activities and, to a large extent, on its basis, rating agencies assign a particular ESG rating to the company. But in addition to reporting, agencies also take into account additional factors. We’ll talk about this “interesting” nuance below.
ESG reporting can also be divided into 2 levels:
Corporate level ESG reporting
A separate report, or part of the annual report, which describes the quantitative and qualitative indicators of the ESG aspects of the company’s activities;
ESG reporting at the asset/asset level
For example, reports from public real estate companies that own large portfolios of real estate. Even special standards have been developed in the field of assessing the quality and operation of specific real estate objects. These standards (ECORE, CRREM, GRESB) are mainly aimed at continuously improving the energy efficiency of a building, reducing carbon emissions and combating global warming. The European Union has developed and operates special programs for energy efficiency and reducing the carbon footprint of buildings (such as the Energy Performance of Buildings Directive), since the operation of buildings is one of the most significant sources of carbon emissions in the world.
But the devil, as usual, is in the details - there is no single methodology in the world for calculating ratings or reporting. But there is a little help for ESG reporting: there are a number of generally accepted standards, a company must choose one of them (for example, the GRI standard).
And in addition to the lack of uniform rules for calculating ESG ratings by rating agencies, the methods themselves are very complex and depend on many factors. It is extremely difficult to create a clear logical relationship: “I’ll do this, and my rating will increase by this much, which means I can attract investments at a rate of not 6%, but 4% and save XX million rubles.”
However, in countries with developed public capital markets (USA, UK, EU, Canada, Australia) there are mandatory requirements for public companies to publish ESG reporting.
It turns out to be a rather closed system - the assessment is complex, it is difficult to assess the benefits, but this must be done.
In addition, many businessmen who are not required to comply with all these requirements do so for a fairly simple reason - to increase competitiveness, to be able to conclude contracts with large and “rich” clients. For example, due to ESG requirements, large international and Russian corporations rent office space only in environmentally certified buildings - this is required by their corporate rules or increases their ESG ratings.
Initiatives supporting disclosure of ESG factors
Now in the world there are a number of “global” initiatives on how to work with ESG reporting. The most famous of them:
Global Reporting Initiative (GRI);
Climate Disclosure Standards Board (CDSB);
ESG Disclosure Standards (Sustainability Accounting Standards Board, SASB);
Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD);
Carbon Disclosure Project (CDP, formerly known as the Carbon Disclosure Project).
Below is a brief comparison of the initiatives.
More details at the link
ESG and business, financing
Visualizing the relationship between ESG data
And to gain “access” to green finance, there are a number of strategies.
1. Elimination Strategies (Negative Screening)
They allow investment projects, individual companies, as well as entire sectors and countries not to be included in the portfolio due to their non-compliance with the established ESG filters .
For example, in the fall of 2019, the Norwegian Sovereign Fund excluded from its investment portfolio the shares of the British company G4S, which violated the rights and freedoms of migrant workers in Qatar and the UAE [ 1 ]. These strategies help avoid ESG risk.
2. Binary choice strategies
Review potential assets for compliance with specific principles (UN Global Compact), industry standards (FSC forest management and chain of custody certification) or Sustainable Development Goals . These strategies do not imply deep integration of ESG factors, but rather a check for compliance with the chosen areas in the field of sustainable development.
3. Strategies for assessing ESG factors
Allows you to track progress in the implementation of projects and initiatives in the field of sustainable development. This way we will get their quantitative and/or qualitative expression in order to include them in the investment portfolio.
Classic examples of such strategies include:
selection of assets based on the specific ESG rating assigned to companies
investments in renewable energy projects that reduce the planned volume of CO2 emissions
individual values of indicators that are set by investors themselves
4. Impact investing
Represents a strategy for monetizing ESG indicators , including for external stakeholders. This strategy assumes the highest accuracy in assessing the impact of ESG factors through financial indicators.
An example of assessing an ESG factor in monetary terms is the monetization of the environmental effect of decarbonization through setting a price on carbon. Let’s recall the example of the purchase of medical equipment from the section “What is the difference between ESG and CSR?”, in which the social delta is expressed through a reduction in the employee’s time away from work and insurance payments. This can also serve as an example of Impact Investing. You can learn more about this concept based on other examples on the Value Balancing Alliance website.
Well, some practical examples
Russia and ESG
What about Russia? We are still at the entrance to this “wave”. As often happens, we are a little behind, and this is a big plus. The most proactive companies can prepare for this “wave.”
Banks are already starting to work on platforms for ESG investing and “PR” this topic. Therefore, it is likely that regulators will also create conditions to stimulate businesses to move to ESG. And the Central Bank published a separate section on its website. And, apparently, the main direction will be in the area of capital construction.
Among commercial banks, the leaders at the beginning of 2022 are Sberbank and VTB
Thus, in October 2021, VTB announced the launch of its platform, which already takes into account more than 20 parameters, and the ESG platform is based on the ESG strategy of the VTB Group, including providing for further steps to support clients in the implementation of initiatives.
We recommend reading 2 small links
Now a little about Sberbank
At its artificial intelligence conference ai journey in 2021, Sber devoted quite a lot of time to this area. In short, ESG assessment will use big data and artificial intelligence for its analytics. And one of Sber’s partners is Bidzaar
You can get acquainted with the company by following the link
In general, so far everything is at the level of “declarations” and minimal actions. We believe that the question “How to apply it in life?” is still being worked out. And in the coming years, this will become an additional factor when assessing businesses that will apply for investment.
Digital and ESG – where is the connection?
The connection here is simple. To have a high rating or meet the requirements, you will have to implement digital. This could be a smart building system to optimize and reduce energy consumption, or data-based management to generate transparent reporting and combat corruption, and increase the level of tax transparency. In general, if you dig deeper into almost any of the indicators discussed above, then for high indicators you cannot avoid the introduction of digital tools. And the basis here will be the use of the Internet of things and end-to-end analytics. There are doubts about blockchain, the technology is too specific, but most likely this will also be one of the advantages.
The figure will help you pass the green financing assessment faster and cheaper.
And while the methodologies have not “ripened”, this is more of a marketing story. However, in the future these will be quite serious tools, and in such scenarios it is better to be in the vanguard, so as not to regret the lost profits and not adapt to the approved standards.
Well, if the topic is interesting to you, we recommend several training courses: