ESG are a set of standards for a company’s behaviour used by socially conscious investors to screen potential investments.-Investopedia
What are Environmental, Social, and Governance policies?
ESG policies consider how a company interacts with the environment, including corporate policies meant to address issues such as climate change. The social aspect of the policy examines a company’s management of relationships with employees, customers, suppliers, and communities where they operate. Governance looks at how the company is run, its leadership policies, executive pay, audits, internal controls, and shareholder rights.
The concept of ESG was developed early this century by United Nations (UN) officials in association with the global finance industry. They argued that ESG data would help protect investments by avoiding material financial risks. Climate change, worker disputes, human rights violations in supply chains, and poor corporate governance would be minimized as a result.
ESG policies’ main aims are:
- To screen investments based on corporate policies and to encourage companies to act responsibly.
- To help investors avoid investment losses when companies engage in risky or unethical practices.
- Encourage more corporations, brokerage firms, and Robo-advisors to offer investment products/ services that employ ESG criteria.
How do Environmental, Social, and Governance policies work?
ESG is designed to encourage investors to look for ethical business practices in the market when investing. Investors are mostly guided by their values in addition to profit. ESG policies are increasingly informing the investment choices of large institutional investors such as public pension funds. ESG investing also has other names such as responsible investing, sustainable investing or socially responsible investing. To assess a company based on ESG policies, investors look at a broad range of behaviors.
- Ethical and values-based investing: These are strategies that enable investors to invest or move on from a company. These strategies are meant to reflect the investors’ political, religious, or philosophical beliefs and values. Take Intentionality, for instance, we value the triple bottom line, and ethically we only support businesses that pay their workers a living wage and regular working hours. Although we are not investors, we can say that we employ ESG policies because we understand their importance.
- Socially responsible investing: In the late 1980s and early 1990s a group of investors decided to not only invest in those that are improving their business practices. The investors also focus on companies that engage in clean technology efforts. For example, these investors looked at companies that denounced social ills such as apartheid and anti-Vietnam war protests.
- Impact investing: Unlike socially responsible investing, which focuses on publicly traded companies, impact investing focuses on private projects. Investors target specific outcomes that can be measured. For example, this investing method can be used to promote sustainable practices such as affordable housing. Affordable housing has both a social and financial impact which makes it the best impact investing example.
- Systems-level investing: This investment strategy helps investors make decisions that take into account a company’s entire portfolio and how it intersects across all assets in the long term. System-level investors use this method to collectively work with other investors. It provides the necessary data to show which companies need to improve their practices by creating industry standards and pushing for public policy changes. Systems-level investing ensures that investors have an agreement on industry standards and what can be improved.
What are some ESG criticisms from its supporters?
Every new concept is open to interpretation, and ESG is not immune to scrutiny. Some people think the term has become broad that is losing most of its meaning. Others point to the prevalence of green-washing, which happens when companies overly compensate for how much they do for the environment. Even the individual who coined the acronym has said the finance industry has sprinkled “ESG fairy dust” on products that don’t merit the label.
Other criticisms hone in on the way fund managers rely on ESG ratings. Some of the scores they use to rank ESG factors are inconsistent and can pose significant threats to the environment and society at large. The term can be corrupted based on each company’s desired outcomes. Some have even suggested that the industry adopt a more mundane term, like ‘material risk factors, in order to avoid confusion and inaccuracy.
ESG supporters having doubts is a problem, not only for the policy implementers but for the environment as well. It is worth noting that some union regulators are watching closely the companies that are exaggerating their ESG practices. Some of their policy-checking strategies include looking into whether ESG funds sold by banks are in breach of claims set out in marketing materials. Some examples include the US Securities Exchange Commission proposing a slate of new restrictions aimed at ensuring funds accurately describe their investments. It is in the companies’ best interests to understand and act on the sustainability preference of their clients.
ESG policies are more important now than ever. Corporate policies are no longer the responsibility of business owners; they now belong to a larger group of experts. This is to encourage responsible behavior towards collective environmental and social practices within industries. Corporate structures are obligated to consider environmental factors such as climate change when conducting business. They are also encouraged to have open policies such as diversity, equal pay opportunities, and safety in the workplace so that they can secure legitimate investments.
Investors are also protected from false advertising companies who use ESG criteria to further their green-washing agendas. The policies also regulate the investors’ values to determine their intentions when investing. ESG ensures that all parties involved in any transaction are fully aware of their rights, but mainly their responsibilities to social, environmental, and governance factors. These responsibilities all rest upon the integrity and honesty of the company, industry regulators, and their investors. The regulating outcomes all depend on the type of investment, but mostly on how sustainability factors are affected.
Every policy has pros and cons, and ESG is not immune to this phenomenon. Its supporters have said that they are no longer sure of the policies’ efficiency because companies have found ways to claim ESG without employing it. This is no surprise because in every industry there are companies that want the greatest outcomes with the least amount of work put in.
The results are green-washing and human rights violations. The best way to deal with these issues is to encourage more honest policy regulations. Checks and balances are also encouraged because we cannot rely on a system that regulates itself without the input of impartial parties and industry experts. ESG’s efficiency depends on the client’s desired outcomes, not just those of investors.