This article outlines the fundamentals of the ESG framework and its three criteria.
ESG (an acronym for Environmental, Social, and Governance) is a tool to evaluate a company’s attractiveness — beyond just the balance sheet — how holistically attractive the company is or can be.
As an example, the ESG framework can help a business stand out for its exceptionally sustainable supply chain that would otherwise go unnoticed and its value unmeasured. The framework also helps this ‘environmental value’ created by a responsible business, get the recognition it deserves from investors and other stakeholders.
Accordingly, the framework helps the stakeholders understand how an organization is managing risks and treating opportunities around the three ‘ESG’ pillars.
ESG framework helps investors screen potential investments to find companies with values that match their own.
ESG Investing, therefore, refers to the process of considering environmental, social, and governance (ESG) factors when making investment decisions (source: OECD Report.)
In 2022, roughly 89% of investors took ESG issues into consideration in their investment approaches in some way or another.
For organizations — ESG standards measure their impact on society and the environment, as well as assess how transparent and robust their governance is in integrating ESG practices into their operations.
From its earliest mention in a UN Report (‘recommendations’ to the financial market actors to integrate ESG issues) — it has now evolved into ESG investing and ESG reporting (disclosures).
Although this evolution itself made ESG mainstream — there is no standard, universal ESG framework around yet, or a common law mandating one.
Multiple agencies specializing in ESG scoring have come up with slightly different rating systems to evaluate how well the company under study addresses the risks related to ESG issues. For example, ASML Holdings N.V. (Netherlands) holds an ESG score of 73.13, suggesting a strong position in being able to manage sustainability issues. Even if this score varies with the institutions evaluating them, the investors can still make the most out of the ratings.
Likewise, multiple regulations are in process to transition the existing voluntary market-led ESG reporting into a stronger regulatory system.
Most prevailing laws aren’t designated ‘ESG regulations’ as such. But they encompass several criteria that fall under the three pillars of the ESG framework in some form or other. For example, the EU’s Green Claims Directive is a set of measures against Greenwashing and is applicable to the environmental (E) pillar, discussed in detail below.
All three criteria are greatly intertwined and overlap each other in many instances. But at the same time, some criteria will be of more importance to certain organizations. For example, the energy sector will have to prioritize its decisions for the ‘environment’ pillar early on, compared to the financial sector.
Factors and issues that answer the above questions are as follows:
| Environmental | Social | Governance |
|---|---|---|
| Organization’s energy consumption. For example, if the company has put measures in place to transition to renewable energy sources. | Community relations: the relationship between the organization and the workforce. | Corporate governance that includes the internal system of practices, controls, and procedures promoting transparency and accountability. For example, conducting board elections, embracing gender parity on the board of directors, or practicing ESG disclosure practices are factors that reflect effective governance. |
| Impact on climate change: company’s environmental impact covers all its products and/or services, supply chain, and operations. Company’s emissions: direct and indirect greenhouse gas emissions (or carbon footprint). For example, we carried out a simplified life cycle assessment (LCA) to measure the impact of Fairmat’s product and service offers on climate change. | Company’s take on diversity and inclusion. Policies that protect employees against all forms of discrimination or sexual misconduct. (Refer Fairmat’s Well-being Charter) Workplace health and safety. Company’s measures for improving employee productivity. | Company’s leadership, executive pay and perks. |
| Resiliency against physical climate risks, such as floods and fires.Management of reputational risks. | Company’s commitment to fairness and equality. Providing equal social opportunities and access to quality healthcare, finance, and communication. Fair compensation (Refer to Fairmat’s Salary Grid), employee engagement, responsible investments and workplace culture. | Business ethics: transparency with the stakeholders about all its activities and decision-making (even the ones related to environmental and social criteria). |
| Waste generation and its management: If the business is consciously taking measures to reduce, reuse and recycle the waste it produces. (Read about the 5Rs of Waste Hierarchy) | Product or service liability, such as its quality privacy, data safety, health risks, etc. | Shareholder rights, audits, and independency. Managing anomalies like corruption, bribery, or fraud, etc. |
| Other resource consumption: water use, land use, raw material sourcing, etc. Green investments in innovative Clean technology, etc. | It also extends to the organization’s relationship with supply chain partners (such as ethical supply chain labor standards) | |
To conclude, companies don’t necessarily have to bend over backward, incorporating all ESG pillars into their existing organization. Nor should they completely overlook the framework if they don’t have investment plans to pursue. But adopting ESG principles is an essential component of business growth.
McKinsey&Company has stated five ways by which a strong ESG proposition can create value for businesses by reducing downside risks and costs, and uplifting productivity, appealing to employees and customers, among other things.
Regulations projections already favor the ESG framework, and it is only a matter of time or competition before all businesses will voluntarily or through regulatory pressure start reporting on their ESG achievements.
Along with the individual contributions to ESG pillars, Fairmat is backed by RAISE Group’s philanthropic arm, RAISE Sherpas (RAISE Phiture, 100% non-profit investors), who support their responsible portfolio companies in their trajectory of change.
