By Anca Enache

If your answer is ‘No’, then you might want to change that.

You’ve probably heard the term mentioned in the media, but you did not give it much thought. Why would you? In order to ‘do good’ you would probably have to sacrifice some of your profits and shareholder returns during the process.

While you were ignoring it, others took action. ESG Investing in the U.S. reached $12 trillion AUM (Assets Under Management) by the end of 2018 [26 percent (1 in 4!!!) of all AUM in the U.S. and a 36 percent increase from 2016].

Some of the environmental factors (company’s impact on the Earth, in both positive and negative ways) are: carbon footprint and carbon intensity; water-related issues; usage of renewable energy; recycling and safe disposal practices; green technologies and infrastructure; climate change disclosures; and greenhouse gas emissions.

Among the social factors (people-related elements within the company and society) we can list: employee treatment and benefits; employee engagement; staff turnover; employee training and development; employee safety policies; diversity and inclusion in hiring and opportunities offered; higher purpose of the business; customer service receptiveness; consumer protection disputes; and, ethical supply chain sourcing.

As far as governance factors (management/board dynamics and how they relate to stakeholders) go, here are a few examples: executive compensation and perks; compensation tied to metrics that drive long-term business value; diversity of the board of directors and management team; board of directors composition; chairman and CEO separation of roles; directors voting process; stock structure; transparency in communicating with shareholders; and, history of lawsuits brought by shareholders.

What is ESG investing? The term was first introduced in 2005 in a report produced by Ivo Knoepfel, “Who Cares Wins”, as a result of a meeting held the year prior between former UN Secretary General Kofi Annan and 50 CEOs of major financial institutions. ESG investing basically means that investors take into consideration the ESG factors within a company, in addition to the usual financial aspects, to drive buy-hold-sell decisions.

ESG factors represent topics that are not part of the traditional financial analysis, but they do have an impact on the company’s value creation. For investors, ESG data is extremely important to identify the companies that are well positioned to face the challenges ahead and to avoid the ones that are likely to be defeated.

There is a direct correlation between high ESG companies and high value creation and this conclusion is backed up by a variety of sources. I will mention only a couple here:

• In its ‘Enhancing Economic Value With ESG’ 2018 report, MSCI states that “Among a universe of companies that have generated substantial value for their shareholders over the last decade (Jan. 2007 – Dec. 2017), we found that companies with strong management of industry-specific ESG risks and opportunities outperformed peers with poorer management of those same ESG risks and opportunities over the five year period from Jan. 2013 to Dec. 2017.”
• Goldman Sachs declared at the Sustainable Finance Innovation Forum 2018 that “There is growing consensus that integrating material ESG factors correlates to long-term financial returns and can help generate alpha”.

Not convinced yet about the importance of reporting on ESG? Many studies and surveys have been conducted around millennials and sustainable reporting. According to Morgan Stanley’s Institute for Sustainable Investing’s 2017 survey “86% of millennials are interested in sustainable investing, or investing in companies or funds that aim to generate market-rate financial returns, while pursuing positive social and/or environmental impact. Millennials are twice as likely as the overall investor population to invest in companies targeting social or environmental goals. And 90% of them say they want sustainable investing as an option within their 401(k) plans.” Bank of America Merrill Lynch predicted that in the next 20 to 30 years, millennials could bring in between $15 trillion and $20 trillion into ESG investments in the U.S.

According to the sixth annual monitoring and analysis of S&P 500 Index Company Sustainability reporting by the Governance & Accountability Institute, “82% of the S&P 500 companies published corporate sustainability reports in 2016”.  All good here, but is that really helpful? A comprehensive ESG report can be up to 200 pages long and uses massive resources to produce. And with all this effort, they are still hard to use by investors due to lack of consistency across reports, making them almost impossible to use when comparing performances. Creating a reporting framework is a solution to this problem, and there are a number of organizations out there that are working on just that, developing a reporting framework.

Three of the most known ESG reporting standards/frameworks are developed by GRI, SASB, and IIRC. Each of them created standards with focus on materiality, but they have different definitions for ‘materiality’, depending on who the users of the report are. GRI has a more general scope and its target audience is represented by all stakeholders. IIRC also has a general scope, but its target audience is represented by investors. SASB’s target audience is also represented by investors, but the scope is industry-specific, identifying the factors that have or are likely to have a material impact on the financial condition and operating performance of the company.

SASB created a Materiality Map that can be used to identify the material factors most likely to impact value creation depending on the industry.  The factors listed are to be used as guidance. It is the company’s ultimate decision what material factors on which to report.

Regardless of where you are on the ESG reporting scale, keep it up! If you are just starting, congratulations! You took the first step towards a sustainable future for your company. If you are a veteran in this field, congratulations! Your work so far will serve as an example and inspiration for the rest of us. And don’t stop here. Keep going. You have already seen the rewards. They will only get bigger.

Anca Enache is the CEO and founder of 3P Impact Consulting. She focuses on organizations big and small to help them find sustainable ways to grow their business.