Introduction to Sustainable Finance and the ESG Framework

Introduction to Sustainable Finance and the ESG Framework

Today, most nations advocate the transition to a low-carbon, resource-efficient, and sustainable economy. As a result, companies are becoming more conscious of their environmental, social, and governance (ESG) footprints. Furthermore, an increasing number of investors consider ‘Sustainability’ a critical component of their investment strategy.

This article will discuss the intricate details of how sustainability works in the financial sector. But first, let us understand what sustainable finance and ESG investing are.

What is Sustainable Finance?

Sustainable finance refers to financing and investment decisions concerning a business’ environmental, social, and governance (ESG) aspects. Other terms that describe it are—sustainability finance, social investment, socially conscious, socially responsible, green, ethical, or impact investing.

Sustainability is an umbrella concept encompassing everything a firm does to improve its CSR performance. Yet, the realm of ‘sustainable’ has a lot of questionable areas. ESG investing is looking to change that. It uses set criteria to grade investments. It aims to clarify what sustainable finance should look like precisely.

Understanding ESG Investing

ESG is a long-term investment that assesses a company’s ethical contribution to its stakeholders based on the premise that only major investors can drive corporations to act ethically.

Let us briefly consider the three elements of ESG:

Environment (E)

The environmental criteria look at how a company acts as a custodian of the environment. It comprises the below aspects:

  • The energy a corporation consumes;
  • The waste it produces;
  • The resources it requires; 
  • Its repercussions on living organisms.

Social (S) 

The social criteria examine how a corporation maintains connections with employees, suppliers, consumers, and communities. It includes labour relations, diversity and inclusion. This criterion also evaluates the corporation’s work to give back to communities, empower marginalised populations and undertake interventions to improve the socioeconomic status of those people.

Governance (G)

Governance comprises the processes, rules, and procedures a firm uses to manage itself. The term also governs how companies:

  • Make effective decisions;
  • Comply with the law;
  • Meet the needs of external stakeholders.

It has recently become even more vital to think about and proactively act on ESG. For instance, Larry Fink (chairman of Blackrock)—the largest asset manager in the world, talks about the tectonic shift towards sustainability. In his letter to investors and CEOs, he says, ‘The transition will transform every company and industry to a net zero world (sic)’.

Why Are Investors Investing Using The ESG Framework?

The reasons for taking a sustainable investment approach are numerous and have a positive impact beyond financial performance. Some investors see it as a way to boost financial returns, while others see it to live out their principles or beliefs. For instance, investors might not invest in companies selling alcohol or tobacco because they consider it morally objectionable. 

survey by Deloitte Global and Forbes Insights questioned 350 CEOs from the Americas, Asia, and Europe in April 2020. The survey aimed to determine the impact of their companies’ sustainability activities. According to the findings, 59% of businesses saw an increase in revenue and 51% saw an increase in profitability. In addition to improved financial outcomes, 37% saw a meaningful influence on the environment, while 38% noticed increased staff morale.

Furthermore, a strong ESG culture can help a company’s reputation. It allows the stakeholders to acknowledge the company’s efforts to be environmental custodians and other social issues. According to Morgan Stanley’s 2017 survey, 75% of individual investors are interested in sustainable investing. They envision having a sustainable portfolio because of the numerous benefits it offers.

Here are the two evident benefits of ESG investing:

1) In some cases, ESG investing assists a portfolio in outperforming its traditional peers.

2) Minimise volatility and lower risk.

ESG Scoring and Rating

ESG is becoming a top priority for both investors and businesses. However, how do investors tell if a company is doing an excellent job managing ESG risks compared to its peers? The ESG rating aspires to grade organisations on their ESG efforts. It measures a company’s level of sustainability. In simple words, an ESG score is like a credit score or a bond rating. It indicates a company’s capacity to meet its ESG commitments, performance, and risk exposure. 

Third parties, such as agencies and research and analysis organisations, assess a company’s environmental, social, and governance (ESG) performance. They use a set of ESG metrics to determine the scores/ratings. Each agency has its own set of criteria for the same. However, the requirements consider environmental, social, and governance considerations only.

We have mentioned a few prominent ESG Rating Agencies below:

1. Bloomberg ESG Data Services

The organisation offers ESG data for more than 11,800 companies in 100+ countries.

2. Corporate Knights Global 100

It ranks the world’s 100 most sustainable corporations. The rankings are based on a rigorous examination of roughly 7,000 publicly traded companies with revenues exceeding $1 billion.

3. Sustainalytics ESG Risk Ratings

The rating spans over 14,000 companies and encompasses major global indices offering clear insights into company-level ESG risk. Their rating comprises three central building blocks: corporate governance, material ESG issues (MEIs), and black swan events.

4. Dow Jones Sustainability Index Family

The company represents the top 10% of most sustainable companies among the 2,500 in the S&P Global BMI.

5. Thomson Reuters ESG Scores

It measures ESG performance across ten themes for more than 6,000 companies globally.

To conclude, ESG serves as a wake-up call for corporations. 

It causes them to consider their ESG obligation, where risks and opportunities lie. Because of ESG, they comprehend their performance against the wider sector.

Apart from understanding its ESG position, there are various reasons why a business needs an ESG score. The rapid growth of ESG investing, with investors looking for sustainable asset portfolios, is perhaps the most significant.

However, I would leave the readers to answer the below questions:

Is it necessary for companies to reconsider business strategy in light of ESG results? Is their ESG reporting comprehensive enough to reap the benefits of the growing trend in sustainable investing? Or will investors overlook them because of not making their ESG credentials public?

Credits

Authored by Ravi Gupta and strategised by Deepa Sai (founder of ecoHQ)

Ravi is an evangelist for sustainability and an agent for change who thrives on creating an impact with his words. Professionally, with his expertise in end-to-end marketing, he helps to grow businesses (that are conscious of the ecosystem).

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