What Are ESG Principles? Key Factors for ESG Investing

Today’s younger and more socially and environmentally conscious investors haven’t completely changed—like those who came before them, they still want to commit only to companies that will offer them healthy financial returns in the future.

However, they no longer care about the old financial bottom line. Modern investors want to support companies that share their values and will positively change the world.

To assess how committed a given commercial venture is to corporate social responsibility policies and practices, 21st-century investors aren’t satisfied with token social programs or vague answers about planned environmental changes. Instead, they want to be able to measure the results of companies they are considering investing in concrete ways.

To do this, they often consider the key environmental, social, and governance (ESG) principles as they decide where to invest. ESG-based investments are believed to have passed the $20 trillion (!!!) mark, so being a good corporate citizen is about more than “just” doing good in the world today. It’s also an excellent business.

What Are ESG Principles?

ESG principles — in which the all-important three letters stand for “environmental,” “social,” and “governance” — are, at their very core, a set of guidelines that anyone with any stake at all in a particular company can use to assess how well that business is performing in terms of corporate social responsibility.

Together, these guidelines cover all the most important areas in which a company can contribute to the wider world, positively or negatively, and hold itself accountable to all stakeholders.

Companies can use ESG principles to work toward better corporate citizenship practices that improve the world around them. This is usually a complex and well-thought-out process during which a corporate responsibility or sustainability team carefully analyzes a business’s aims and how to implement its overall goals.

Consumers and investors, on the other hand, can use a company’s commitment to these principles as a guide in deciding whether to do business with that particular company.

As more investors emphasize the need to invest only in businesses that share their values and vision for creating a better world, tools are also being developed to help them on this quest.

Brokerage firms, mutual funds, and robo-advisors are all beginning to offer services that help potential investors determine how well companies score regarding ESG principles for responsible investment.

So, how are socially and environmentally aware people who are committed to leaving the world a better place than they found it (or at least than it’s currently in) “vetting” businesses they are considering investing in? Here’s a look at the parameters that may be considered in the process:

Environmental impact

Today, more than ever before, it has become abundantly clear that we all need to make radical changes to mitigate climate change. Serious ESG investors will want to assess how well companies they consider investing in are performing in this area in great detail. They want to see results, not half-hearted commitments to changing course and adopting greener practices at some point in the future.

The process will scrutinize the company’s overall carbon footprint, which includes examining the impact the business currently has on the environment in terms of air quality, pollution, overall energy usage, manufacturing methods, moves toward more sustainable energy, and active mitigation steps.

Social impact

Any effect a company has on the people and communities it interacts with falls under this heading. Hence, assessing a business’s social impact is just as complicated as assessing its environmental sustainability or lack thereof.

A common focus for ESG investors is the company’s workforce, including hiring practices, career progression, healthcare provision, and flexible working hours.

Increased diversity is an important goal in today’s increasingly inclusive environment, and typical ESG investors will look at gender and racial equity parameters as well as how well a business embraces members of the LGBTQIA+ community and people with disabilities.

The wider the company’s scope, the more factors need to be considered under this social impact heading—such as how wastewater practices impact local communities or whether all suppliers have ethical work practices. Customer satisfaction can also fall under this category.

Corporate Governance

This ESG criterion looks at the company’s leadership principles and style. Modern ESG investors want businesses to be transparent from top to bottom, including shareholder voting rights and accounting transparency, as well as opportunities for the workforce to offer feedback. They tend to frown on most traditional types of political lobbying. They want to see open communication and channels of feedback and change between stakeholders and leadership.

How does ESG investing work?

The ESG investing approach is designed to allow investors to positively impact society and the environment. It seeks to invest resources in firms that receive high ratings on their environmental, social, and governance activities from third-party research groups.

These ESG ratings are based on factors such as a company’s carbon emissions, labor practices, corporate governance structures, and commitment to stakeholder interests. Investing through this approach can also provide financial benefits by reducing risk exposure or offering access to potentially uncorrelated returns.

Furthermore, it reduces the potential for investing in companies with poor ESG performance, which could lead to reputational damage. Ultimately, ESG investing offers a meaningful way for investors to contribute to creating a more sustainable world while still achieving financial objectives.

How do environmental, social, and governance (ESG) factors work?

Environmental, Social, and Governance (ESG) factors are a set of standards for a company’s operations that aim to consider the impact of its business on the environment, society, and governance.

The criteria assess how well companies manage their social and environmental impacts and corporate governance practices. To meet ESG criteria, companies must be transparent about their policies and processes related to the environment, social issues, and corporate governance.

For example, a company must demonstrate how it reduces its carbon footprint or develops responsible labor practices. It should also show that it has good internal processes to manage potential risks and conflicts of interest within the boardroom.

By incorporating ESG criteria into business decisions, companies can contribute positively to sustainable development while increasing their competitive advantage by improving investor confidence and employee engagement.

How are ESG scores calculated?

ESG scores measure a company’s environmental, social, and governance activities. To calculate the ESG score of a company, data is collected from several sources such as publicly available information, interviews with experts and stakeholders, and surveys. The data collected is then used to analyze the company’s performance in the three areas of ESG: environment, social responsibility, and governance.

Each area is given a score based on its performance in terms of environmental policies, labor practices, corporate governance structure, and other criteria. The overall ESG score for a company is then obtained by combining the scores for each area. This allows institutional and retail investors to make informed decisions about their investments by understanding how well companies perform regarding sustainability and ethical practices.

What ESG Factors Should You Care About?

Businesses play an enormous and inevitable role in our society — and as such, the investors that back them up do, too. The definition of principles we looked at makes it clear that ESG, as a framework for business ethics, leaves no stone untouched. These guidelines examine how a business relates to every single aspect of the world and how the fact that that business operates in that world changes the company, the planet, and wider society.

There is absolutely no doubt that when you look at the framework of ESG factors and corporate social responsibility (CSR) in general, there is going to be a lot of overlap between the “E”, the “S”, and the “G” in “ESG”. How a company cares for or fails to care for its workers, customers, shareholders, and the local communities it may be impacting easily spills over into the domain of environmental sustainability.

Just as polluting practices have the potential to negatively impact the health, well-being, and even educational opportunities of affected communities, they will also have damaging environmental results. In turn, as such practices are increasingly becoming legally regulated, the ability to perpetuate them without consequence will require heavy but covert political lobbying.

In other words, a business will either be committed to all of the ESG factors, making steps toward progress whenever possible, or fail on all accounts. These principles do not exist in isolation; rather, they intersect more clearly the closer you examine them.

Nonetheless, there is no question that there is space for companies as well as investors to emphasize some ESG factors more than others as they decide how to move forward.

How can you be sure that an ESG investment aligns with my values and beliefs?

That, ultimately, depends on you—meaning you as an individual investor, consumer, or company deciding how to move forward with corporate citizenship fit for the 21st century.

While socially responsible investing involves solely focusing on personal values, ESG investing involves more of a quantitative approach. It uses key ESG criteria in investment analysis to determine one’s exposure to environmental risks. It’s a blend of sustainable investing and socially responsible investing.

Some people deploying an ESG investing portfolio will care most about the environment. It is easy to argue that climate change mitigation efforts are the single most important question of our time.

Unless radical steps are taken to reduce and reverse greenhouse gas emissions and move to a more sustainable model of living and doing business, those who place a higher emphasis on the “environment” portion of ESG principles will say neither the social nor the governance portions of the guideline will be able to have any importance at all.

Companies committed to climate change mitigation will certainly find investors to back them up, and the more radical the progress, the more likely they are to find partners on the journey. Likewise, investors who are committed to building a more sustainable future will be able to find the perfect companies to back them up.

Some will care most about the pressing social issues of our time, believing that change starts with people. In improving living and working conditions for all communities a company touches, it can realize immediate and measurable improvements that matter right now.

Whether a company focuses on flexible working hours for employees, takes a political stand by refusing to work with suppliers from countries well-known for hostile labor conditions, or embraces opportunities for disabled workers, it will gain a measurable reputation boost and attract investors. Investors committed to improved social conditions will also find adequate partners.

The governance portion of ESG principles can be seen as lying at the heart of the other two or even holding them both up — because nothing else is clear without transparency and accountability. ESG data can help companies make better environmental, social, and governance decisions.

How to Integrate ESG Considerations Into Your Investment Practices

Companies discussing how to implement ESG principles and strive toward better corporate citizenship should know that, while being the change in the world that they want to see is certainly a powerful motivator behind adopting ESG principles, there are more selfish reasons to consider ESG too:

ESG investment is on the rise, and companies that have implemented ESG principles and that embrace the role they play in society as corporate citizens, in general, make higher profits and attract more investors. Investors who are female, Millennial, or especially wealthy are more likely to commit to only making ESG investments.
The social principles of ESG — or the “people” portion of the triple bottom line — are incredibly important to the overall success of a business. Adopting increasingly equitable practices leads to happier, healthier, more productive, and more creative employees who will stay with your company for a long time and take it to new heights.
Adopting ESG principles causes profits to rise rather than tank, in a win-win equation that benefits society. Not just investment managers.

Adopting ESG principles, considering ESG training and certification, and establishing CSR teams can only help companies in today’s environment achieve their mission of serving their customers while attaining solid financial returns.

Investors and potential investors can be proud, too. Their commitment to ESG investment is fueling change within businesses worldwide, including those who would not have considered implementing ESG principles without this very real pressure to change.

Commercial ventures, from the smallest ambitious startups to the most well-established industry giants, are now taking their corporate social responsibility commitments to the next level precisely because they know that while the bottom line still matters a great deal, it cannot be the only factor investors consider anymore.

As an investor, all ESG principles for responsible investment should be an important consideration in your investment process. That is true because carefully considering a business’s impact on the environment and the people within it, as well as how it relates to both, fuels positive change from within.

Financial pressure is one of the easiest ways to cause the world you are hoping to live in tomorrow to come about, and the most important principles for ESG investing offer you a path to get there.

FAQs

What are the three pillars of ESG?

ESG is based on three pillars of ESG factors. The first pillar is the environmental factor, which refers to how a company’s operations affect and impact the environment. This includes energy efficiency, carbon emissions, pollution, and waste management. The second pillar is the social factor. This examines how a company engages with its stakeholders and manages its relationships with employees, customers, suppliers, and communities.

Finally, the third pillar of ESG focuses on governance issues such as executive compensation structure, board composition, risk management practices, and corporate transparency standards. These three pillars are essential to understanding a company’s social and environmental impact and help investors make better decisions when assessing potential investments in companies that demonstrate strong ESG principles.

What are the main ESG standards?

ESG standards are criteria for evaluating and measuring an investment’s sustainability and ethical impact. They are becoming increasingly important in the investment industry as they assure investors that their money is invested in investments that align with their values.

ESG reporting involves assessing and evaluating ESG issues such as climate change, human rights, corporate governance, diversity quotas, etc., and disclosing the results to stakeholders. These standards are applied to all sectors of society, from businesses to governments, to ensure the highest possible levels of social responsibility and accountability.

ESG standards promote sustainable practices and protect investors by creating a more reliable long-term environment for their investments. Consequently, these standards have become integral to the investment industry, helping create value for investors and companies through improved risk management and increased transparency.

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