Introducing ESG

In this blog we look at the basics of ESG, why it matters and who should be concerned about its implications. This is the first of four blogs on the subject with future blogs covering Environmental, Social and Governance separately.

What is ESG?

Environmental, Social and Governance are the standards by which the company/organisation stands; how it operates in the world and the standards by which it will be judged.

In essence ESG is about being socially responsible. It is more than polices and statements. ESG covers behaviour, culture and mindset. ESG is not an optional extra, a nice to have or box to tick. It is important and matters to the wider community. Insincerity will be apparent.

ESG and directors duties

Every director is conscious of the requirement to add shareholder value. Shareholders own the company and directors have a fiduciary duty to the shareholders and to act in the best interests of the company. So why go on an an expensive folly implementing ESG polices?

Business has moved on since the 1980’s and 1990’s. The behaviour of Gekko, and the very real example of Enron are no longer acceptable. Adding shareholder value whilst ignoring all other considerations leads to disaster. Concerns about governance standards were raised as early as 1991. The Corporate Governance Committee was established in response to concern about standards of financial reporting and accountability. The resultant Cadbury report was published in 1992. The report sets out recommendations on company boards and accounting systems to mitigate corporate governance risks and failures. Many others including the OECD, World Bank, the US and the EU have implemented many of the recommendations.

Since the Cadbury report, Corporate Governance has developed substantially with a current focus on ESG, not least in light of the climate crisis and COP26.

Companies increasingly have a legal and moral obligation to consider other stakeholders in their decision making process. Failure to do so will ultimately adversely affect shareholder value. There is no conflict between ESG and the needs of the shareholder. Indeed  ESG and profitability are positively correlated.

The benefits of ESG policies

Investors

Investors are increasingly concerned about the environment and social factors when choosing their investments. ESG now accounts for a staggering $2.7 trillion of assets globally according to research by Morningstar. Accordingly there are many corporate investors and ethical investment options available. Such investors will examine the company’s track record and ESG commitments. They will not invest if the company has a negative impact on its community. Investors want environmental risks mitigated for large corporates, for example. Companies who ignore this aspect of their business might experience difficulties when raising capital finance with a resultant higher cost of finance

Banks

Banks want to know that companies with whom they do business with are acting responsibly. They will not want links with corporate failures, especially if it involves bank financing. They are already beginning to ask questions about companies’ ESG policies. This will only increase over time. The answers will increasingly affect banks’ decisions whether to provide loans, open a bank account or continue to operate an account.

Employees

Employees today want more than a 9.00-5.00 job. They want flexibility, a good work life balance. They want to know what polices the company has on Wellbeing. But they also want to know that the company they are working for is not exploiting the community or the environment. The best staff will apply to work for companies with good ESG polices and procedures. Such employees will have shared values with the company. They will work harder being satisfied in their jobs. Fewer days will lost to sick leave with the net result of increased productivity and profits.

Clients

Clients will choose your company for many reasons. Increasingly their decisions will include ESG factors. Financial considerations are not the only motivating factor for clients, especially when operating in a competitive market. This means clients will want more than just a competitive price and good service. Clients want to know that the staff are treated well, that the company is not causing harm, and increasingly clients will want to see how the company is making a positive contribution to society. Company statements on ESG together with action taken could be the crucial factor as to who clients choose to do business with.

These are only some examples of the stakeholders and their requirements. There are many more including suppliers, government, charities, the local community and local businesses. There will be individual benefits of good ESG policies for each separate stakeholder.

A word of warning

There is a lot of virtue signalling around ESG and we have already looked at the dangers of insincerity. Elon Musk has called ESG is a sham. This after Tesla was excluded from an ESG criteria rated index that included ExonMobil in the top ten. This matters when you think back to the $2.7 Trillion of assets invested. There is currently little by way of transparency and standardisation of scoring. Regulations and ratings will no doubt improve over the years, but that is no reason to ignore ESG now.

Where to start with ESG policies?

It is no longer acceptable to ignore the very many stakeholders in the business as we have seen. Therefore the first stage to implementing ESG policies is to identify all the stakeholders. Then review how your business affects each one. Look at the needs of each separately. Legislation will govern many minimum requirements such as the minimum wage, annual leave, health and safety etc. But that is only the start. Review the actions and commitments of government. This could include the statements on the environment, congestion charges, targets for carbon emissions. Look at these goals and see how your business can help to achieve them. How you can begin to make a real difference and contribution to the community, country and the world. Once you do so you will become an advocate for change with a reputation to match and reaping the many rewards highlighted by this article.

Where to start might appear to be a strange way to conclude a blog, but ESG is only in its infancy. Some have taken more steps than others but there is a long way to go before businesses can truly say that they are making a positive impact on Environmental, Social and Governance. As mentioned in the opening, we review each of these aspects separately in other blogs.

Please contact us should you require assistance in reviewing or preparing ESG policies and procedures, or if you would like assistance with any of your governance or compliance requirements.