What are Environmental, Social, and Governance (ESG) criteria?
Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. (quote taken from Investopedia)
Origins and growth of ESG
Society is gradually waking up to the environmental impact of global industrialisation. Today there is a significant drive to tackle this issue. Progressive governments across the globe are enacting legislation to ensure that commercial enterprises publicise the proactive steps they are taking to minimise their impact on the environment and society. This has extended to corporate governance, such as management structure, corporate behaviour, business ethics, transparency, and financial prudence.
Authorities are ensuring that large enterprises support this infrastructure and require them to provide annual reports to shareholders on their commitment to what is now termed ESG.
This information is rising in importance and is beginning to be reflected in share values, which naturally is of major interest to investors. In the United States, for example, this is mainstream and becoming an important measure of value for fund managers and institutional investors.
Enterprises are recognising that their contribution to these global issues are an important consideration in terms of potential investment, brand and reputation. Some market commentators believe that ESG criteria are becoming the norm in the investment world. It may be argued that ESG will no longer be seen an ‘accreditation’, but a hygiene factor for all large organisations. The Commission of Sponsoring Organisations of the Treadway Commission, known as ‘COSO Framework’ argue that ESG issues are central to a company’s risk decision making and need to be integrated into enterprise-wide risk management.
In 2018, a European Union directive (known as ‘MiFID II’) came into effect, mandating financial institutions in EU Member States to include Environmental, Social and Governance in their investment decisions. This was taken forward by ESMA (European Securities & Market Authority).
The UK’s national regulatory authority, the Financial Conduct Authority (FCA), has however stepped back from mirroring ESG in the UK according to the directive. Brexit gives the UK legal grounds to resist the introduction, and the FCA has recognised that there are still a number of inconsistencies in how ESG regulations are to be applied. In particular, ‘ESG scores’ depend on the availability of hard data, how the data is collected and then interpreted by market analysts. The lack of available benchmarks and standard definitions also mean it is difficult to make a fair comparison.
In March 2021, the FCA took its first real step forward, in a Policy Statement, mandating that enterprises provide an ‘ESG disclosure’ in accordance with recommendations given by a Task Force on Climate-related Disclosure, which is looking for an internally agreed set of measurements. In due course this will filter down to all asset management companies.
In addition, a new Climate Financial Risks Forum (combining the FCA & Bank of England’s Prudential Regulatory Authority) are currently considering how best to enhance climate related disclosure by financial advisers, asset managers and life companies. Trustees of occupational pension schemes have already been required to communicate its position on ESG to scheme members.
On the surface the introduction of ESG is reflective of the planet’s precarious position. Our clients may also be encouraged by the proposition that their money is being invested in ethical enterprises which have a stake in the environmental issues.
We also believe that ESG will become an increasingly important determinant of value, as the principles of ESG lay the foundations for long term commercial sustainability. We think that ESG will continue to evolve and this evolution will add greater transparency, improve comparability and ensure organisations that adopt ESG at a cultural level are recognised for doing so.
We do believe that fund managers need to recognise the importance of investing money in enterprises which do not have a negative impact on the environment and society. For this reason, we are actively considering a specific fund sector which aims to invest in enterprises which have a strong leaning towards sustainability, which naturally includes environmental, social and governance factors. We hope to have an appropriate investment solution available for the second part of 2021.
If you would like to understand more about the ethical enterprises we invest our clients money in and how we deliver investment support, email us at email@example.com, call one of our offices to speak directly with an adviser or complete the form below.