ESG Explained: Navigating the Pillars of Environmental, Social, and Governance in 2024

What Does ESG Stand For?

ESG stands for Environmental, Social, and Governance. It is a framework for assessing how well companies perform in their sustainability, ethical practices, and corporate governance. ESG criteria are evaluated by investors, businesses, and stakeholders to gauge a company's impact on society and the environment, as well as the quality of its internal governance.

Environmental

The Environmental aspect evaluates how a company interacts with the natural environment, including its impact on climate change, resource usage, and ecological conservation. Key factors of the environmental pillar of ESG include:

Reducing carbon footprint to lower greenhouse gas emissions, using strategies such as decarbonisation, buying carbon credits, and setting net-zero goals.
Improving resource efficiency by optimising the use of water, energy, and raw materials, which helps reduce environmental impact and operational costs.
Enhancing pollution and waste management by minimising waste production, promoting recycling, and implementing proper disposal practices to reduce pollution.
Protecting biodiversity by limiting operational impacts on ecosystems and wildlife, supporting the preservation of natural habitats in surrounding areas.

Social

The Social component considers how a company manages relationships with employees, suppliers, customers, and communities. It reflects the company's commitment to ethical practices, human rights, and social well-being. This covers:

Fostering employee welfare by promoting diversity, equity, inclusion, workplace safety, and upholding employee rights.
Strengthening community relations through engagement, philanthropy, and volunteer efforts that support local communities.
Ensuring customer responsibility by maintaining product safety, respecting customer privacy, and adhering to ethical marketing practices.
Upholding ethical supply chain management by promoting human rights and responsible sourcing practices across all suppliers.

Governance

The Governance pillar addresses a company's internal structure, decision-making processes, and accountability. Key considerations include:

Enhancing board diversity and structure by ensuring varied representation and preventing conflicts of interest.
Aligning ethical leadership with long-term goals through fair executive compensation and ethical decision-making.
Increasing transparency by openly disclosing financials, tax strategies, and compliance with regulatory standards.
Strengthening anti-corruption policies to prevent fraud and promote ethical business practices.

How Does ESG Work?

ESG provides a structured approach to evaluate a company's commitment to sustainability. The specifics can differ depending on industry, company size, and geography, but generally speaking, companies working on their ESG will do a combination of the following:

Collecting data on environmental impact, social initiatives, and governance practices. This would be done by conducting internal audits, gathering stakeholder feedback, and implementing third-party assessments.
Adopting reporting frameworks like the Global Reporting Initiative (GRI) or Sustainability Accounting Standards Board (SASB) for consistent reporting, which allows for better comparisons across companies.
Generating ESG ratings with agencies such as MSCI and Sustainalytics that score companies based on specific criteria, helping investors assess sustainability performance.
Basing investment decisions on ESG scores to identify companies aligned with sustainability goals.

History of ESG: How Did ESG Start?

The concept of ESG has evolved over several decades, influenced by early movements in ethical investing and corporate responsibility:

Early Roots: The roots of ESG can be traced back to the 18th century, when religious groups began avoiding investments in industries like alcohol, tobacco, and gambling. This ethical stance laid the groundwork for modern socially responsible investing (SRI).
1970s and 1980s: During the 1970s, the concept of socially responsible investing gained momentum, driven by campaigns against issues like apartheid in South Africa. Investors began to demand that their money be used ethically.
2000s - Formalisation: ESG became more formalised in the early 2000s. In 2006, the United Nations launched the Principles for Responsible Investment (PRI), encouraging institutional investors to consider ESG factors in their decision-making processes.
2015 Onwards: The 2015 Paris Agreement, coupled with increased focus on climate action, further solidified the importance of ESG. The Task Force on Climate-related Financial Disclosures (TCFD) was introduced to improve transparency around climate risks.

Why ESG Is Important for Business

Integrating ESG principles into business operations offers several tangible benefits:

Companies that fail to address ESG risks, such as climate change or labour rights violations, can face regulatory penalties, reputational damage, and loss of investor confidence. Studies show that companies with strong ESG practices tend to outperform their peers during crises.
Investors are increasingly focusing on ESG criteria. According to a 2023 report from MSCI, funds incorporating ESG criteria saw inflows of over $150 billion globally. Companies with robust ESG practices are more attractive to these investors. - Source
Consumers prefer brands that demonstrate responsibility towards society and the environment. Companies with clear ESG strategies often benefit from increased customer loyalty and positive public perception.
As regulations around sustainability reporting become more stringent, having a solid ESG framework ensures compliance and prepares businesses for upcoming mandates.
Younger generations are particularly concerned with the ethical conduct of their employers. Companies that prioritise ESG tend to attract and retain talent more effectively.

Will ESG Become Mandatory?

As sustainability becomes a global priority, ESG reporting is moving towards mandatory compliance status in many jurisdictions:

In the European Union, the Corporate Sustainability Reporting Directive (CSRD) requires companies to disclose detailed sustainability information as of 2024. This directive applies to a wider range of companies in comparison to the previous Non-Financial Reporting Directive (NFRD).

How to know when your company must be compliant with ESG reporting in Europe

ESG Compared to Other Concepts

Concept	Definition	Key Differences
CSR (Corporate Social Responsibility)	A business model where companies self-regulate to create positive impacts on society.	CSR typically involves voluntary actions, focusing on philanthropy and community support, rather than measurable criteria.
SRI (Socially Responsible Investing)	An investment approach that considers social, ethical, and environmental impacts alongside financial returns.	SRI focuses on ethical alignment with investor values; unlike ESG, it may not use specific metrics or standardised scoring.
CSRD (Corporate Sustainability Reporting Directive)	An EU mandate requiring companies to report detailed sustainability practices.	CSRD enforces mandatory reporting within the EU, promoting consistency; it complements voluntary frameworks like ESG.
Sustainability	The long-term maintenance of resources and ecosystems to support future generations.	Sustainability is an overarching goal; ESG, CSR, and CSRD are frameworks and regulations used to achieve this aim.

The Future of ESG

The trajectory for ESG is promising, with increasing adoption and integration across industries:

Advancing technology through AI and data analytics is transforming ESG measurement and reporting. New tools are automating data collection, delivering more accurate insights into environmental and social impacts.

Moving toward standardisation as the demand for consistent ESG reporting grows. The International Sustainability Standards Board (ISSB), established by the IFRS Foundation, aims to create global benchmarks for sustainability reporting.
Fostering collaboration across sectors, with partnerships between companies, governments, and NGOs expected to tackle shared challenges like climate change, inequality, and resource scarcity.
Driving impact beyond compliance as companies increasingly see ESG as a foundation for innovation, market opportunities, and a competitive edge.

Key Takeaways

ESG stands for Environmental, Social, and Governance. It is a comprehensive framework for assessing a company's sustainability practices and governance quality.
Effective ESG practices help companies mitigate risks, attract investors, comply with regulations, enhance brand loyalty, and retain talent.
Regulations like the CSRD in the EU are moving ESG reporting towards becoming mandatory.
ESG differs from CSR, SRI, and other frameworks by focusing on measurable metrics and often carrying regulatory weight.
Technological advances, standardisation, and collaboration will shape the future of ESG, making it integral to business success.