Environmental Social and Corporate Governance

Definition

Environmental, Social, and Corporate Governance (often abbreviated as ESG) is a term first introduced by a 2004 UN report identifying a range of important issues that are deemed not sufficiently addressed in traditional financial analysis of investments. The report includes recommendations for the financial industry to better integrate environmental, social and governance issues in analysis, asset management and securities brokerage.

Who Cares Wins

The 2004 report titled "Who Cares Wins" was compiled as a joint project of various financial institutions. It draws from the "Global Compact" initiative, launched in July 2000 by United Nations Secretary-General Kofi Annan. The initiative aimed to bringing companies together with UN agencies, labour and civil society to support ten principles in the areas of human rights, working conditions, the environment, and anti-corruption.

• The report avoids using the terms Sustainability and corporate responsibility arguing that they are subject to misinterpretation. The ESG terminology is introduced as a more granular framing.
• The report focuses on issues which have or could have a material impact on investment value. It uses a broader definition of materiality than commonly used - one that includes longer time-horizons (10 years and beyond) and intangible aspects impacting company value.
• The report stress the special importance of the "G" pillar (Sound corporate governance and risk management systems) as crucial pre-requisite to successfully implementing policies and measures to address environmental and social challenges. It argues that it is the governance pillar that interlinks the environmental and social dimensions into a coherent framework.
• Identifies a range of ESG Opportunities in the conventional (financial) sense.

Development

In the intervening years since the original report the ESG movement has grown from a corporate social responsibility initiative launched by the United Nations into a global trend and financial markets practice that is in some shape or form affects multiple trillions of financial assets. Renewed impetus in particular after the Paris Agreement committed participating countries to limit global temperature rise to well-below 2°C above pre-industrial levels and pursue efforts to limit warming to 1.5°C setting tangible targets that place particular emphasis on the "E" of ESG. Further momentum has been given by the introduction of the EU Sustainable Finance Taxonomy.

Issues and Challenges

• The degree to which considering ESG Factors may suppress or enhance financial returns
• Difficulty of defining intangible factors, may of which have strong cultural roots
• Difficulty in standardizing the measurement and reporting of ESG factors
• Lack of coherence between the three ESG pillars
• Very diverse and broad scope within the three ESG pillars

See Also

• Sustainable Finance
• ESG Risk Management