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As the corporate world becomes more aware of the need to incorporate ESG criteria into business planning, it is important to differentiate between sustainability goals and ESG practices. Sustainability is a central part of ESG policy: a sustainable business will have an ESG policy but ESG factors extend far beyond the boundaries of sustainability.
The prefix ‘green’ has become shorthand for any action, product or programme with the good of the environment at its heart. Subsequently, it has become so overused as to be near meaningless. In the same vein, ‘sustainability’ has become a well-worn and over generalised term, lacking in clear meaning.
To précis the Oxford English Dictionary, in an environmental context sustainability is the “avoidance of the depletion of natural resources in order to maintain an ecological balance”. But it has come to encompass any and every business practice that can be classed as ‘doing well by doing good’.
Sustainability has become interchangeable not just with ‘green’ activity, but with other well-meaning phrases, including corporate social responsibility (CSR) and triple bottom line. This last requires a company to include people and planet as well as the profit line on its balance sheet.
The latest popular substitute for sustainability is ESG performance. In this case, however, there is an important differentiation between the two in terms of scope. ESG factors include every business practice related to environmental, social and governance issues. This spans not only recycling and carbon emissions, but also corporate governance and health and safety policies. It includes charitable activities, engagement with the local community. And it touches on everything in between.
Perhaps the defining characteristic of ESG is as a reflection of how a business impacts its stakeholders. The supply chain, employees, customers, wider community, shareholders, board of directors and campaigning NGOs are all invested in an organisation’s ESG performance to a greater or lesser extent.
The distinction between sustainability and ESG is particularly marked in the realm of investing. Sustainability investing was originally based on selecting socially responsible shares. Portfolios were built that excluded companies with negative environmental or social impacts, or morally questionable business practices. It was largely accepted by asset managers that such funds would perform worse than the market average. This investment strategy sacrificed clear profit for a clean conscience.
ESG investing is the origin of the term ESG as we know it, with a specific set of issues being grouped together by shareholders to form long-term investment strategy. It bases investment decisions on a far wider set of criteria than ethical investing. These are not exclusive to environmentally and socially conscious business practices. Rather than simply screening out organisations or sectors based on specific criteria, such as animal testing, child labour, or profiting from tobacco or gambling, ESG investing seeks to identify and rank businesses that exhibit desirable characteristics.
These characteristics fall into far broader categories than those covered by environmental sustainability. Executive remuneration, diversity of boards, treatment of employees, health and safety record, and community engagement all fall under the ESG umbrella.
Most importantly for shareholders, businesses with strong ESG policies have been shown to have better financial performance over the long-term. They have been shown to offer greater returns than the wider capital markets. This marks a positive, measurable evolution from the early days of ethical investing.
‘Measurable’ is a key word in the differentiation between sustainability and ESG performance. The ability to measure ESG policies using specific metrics has allowed investors to benchmark ESG attributes. This has led to greater precision in evaluating the potential of companies in the field of proactive ESG behaviour.
The scale and complexity of ESG criteria has required the development of ESG scoring or ratings as a means to rank businesses on their environmental, social and governance policies. At a more sophisticated level, an ESG intelligence solution can provide real-time analysis of a company’s ESG profile.
The importance of such tools both includes and goes beyond shareholder interests. The rise of stakeholder capitalism has created a growing need for businesses to balance the priorities of all stakeholder groups. These include, but are not limited to, employees, customers, local communities, and future generations. This makes it vital for them to be aware and in control of their ESG profile and liability.
With demands for transparency and conscious action coming from a broad base of stakeholders, corporate sustainability has had to evolve.
It has travelled via corporate social responsibility into ESG policy. In doing so, it has evolved from a nice to have and a risk to be mitigated to a must-have source of competitive differentiation and opportunity.
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