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ESG 101: What is it and why now?

Jul 06, 2022

ESG is an acronym for environmental, social, governance. Companies that engage in ESG reporting provide transparency around their impact and risk in issues relating to environmental sustainability, social responsibility and corporate governance. 

Investors look to ESG as an indicator of a company’s long-term financial health and resiliency to risk. Meanwhile, consumers and potential employees are looking at companies’ ESG ratings to reward good corporate citizenship – spending their dollars with companies that support their values.

What does ESG reporting include?

ESG reporting is voluntary. While there are some standard frameworks companies can use, an organization’s ESG priorities will vary depending on its values, its industry and its size and place in the marketplace.

For example, food and clothing manufacturers might both be concerned about sustainable farming. However, the clothing manufacturer might also focus on labor standards throughout the supply chain, while the food producer might place a greater emphasis on animal welfare.

These are some of the issues and metrics companies might be tracking:

Environmental

How is the company using resources and managing its environmental impact? Examples:

  • Carbon emissions
  • Climate impact
  • Energy efficiency
  • Green supply chain
  • Pollution
  • Renewable energy
  • Resource consumption
  • Waste management

Social

How is the company fostering well-being for everyone in its circle of influence (employees, customers, communities)? Examples:

  • Community investment
  • Data privacy
  • Diversity and inclusion
  • Labor standards
  • Pay equity
  • Sourcing and supply chain

Governance

How is the company holding itself accountable for ethical leadership and fiduciary responsibility? Examples:

  • Audit and oversight
  • Board makeup
  • Bribery and corruption
  • Executive compensation
  • Transparency
  • Whistle-blower protections

Why ESG and why now?

Today, ESG efforts aren’t just good for society, they’re good for business too. Evidence suggests that companies with a strong ESG strategy tend to perform better, long-term, than companies without one.

A study from NYU Stern Center and Rockefeller Asset Management found a positive correlation between ESG and financial performance in 58% of cases, a neutral impact in 13%, and mixed results in 21%. Only 8% showed ESG with a negative link to financial performance.

The authors concluded that “Improved financial performance due to ESG becomes more marked over longer time horizons.” Furthermore, they found that ESG investing appeared to provide downside protection during a crisis.

Reports from leading financial analysts seem to support this argument. In the first half of the pandemic, for example, large funds with a strong ESG component outperformed the broader market, according to a report from S&P Global. Analysis from Morningstar and academia also found that stocks with high ESG criteria perform better during a crisis. (To be fair, Wall Street Journal analysis suggests that stock performance is inconsistent, with top-ranked ESG stocks sometimes beating the market, sometimes lagging.)

Growing investor demand for ESG

Increasingly, investors and lenders are using ESG data to assess a company’s strength and future performance. This is happening at the macro and micro level, with both institutional and individual investors.

Just how big is the demand? ESG funds received about $51 billion from investors in 2020, more than double the amount invested in 2019. That represents about a quarter of the money flowing into all U.S. funds, according to Morningstar. Other analysts have pegged global sustainable investment at $35 trillion in assets under management in 2020.

Meanwhile the Climate Disclosure Project (a leading ESG index) reports that more than 680 investors with over US$130 trillion in assets and 200+ large purchasers with over US$5.5 trillion in procurement request that companies disclose environmental data through their rating and validation system.

How ESG builds value

But why does a focus on environmental, social, and corporate governance issues lead to better performance? Research and analysis suggest ESG influences financial performance and value creation in the following ways:

  • Driving growth – through innovation and evolution
  • Access and approvals – good corporate citizens may be more likely to win public-private partnerships, licenses, resource extraction contracts, etc.
  • Cutting costs – reducing waste, lower energy consumption
  • Reduce regulatory and legal challenges – earn subsidies, avoid fines and enforcement actions
  • Meeting consumer, investor and lender demand
  • Managing reputational risk
  • Customer retention and improved brand perception
  • Boosting employee retention and engagement

In summary, a strong ESG program can be an indicator that your company is managing its risks, reducing costs and proactively evolving to stay ahead of market demands.

How Wipfli can help

Many organizations are identifying their ESG impact and developing strategies to prioritize and disclose ESG. If you’re interested in exploring ESG and learning how it can benefit your business, learn more about how we can help on our ESG services web page.

Or learn more with these educational resources:

Author(s)

Robert D. Cedergren, CPA, CGMA, CITP, CISM, CISA, CGEIT
Partner In Charge, Risk Advisory Services
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