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Environmental Social Governance (ESG): An Introduction

Environmental Social Governance (ESG): An Introduction
Mehmet Çakmak
Senior Consultant

WHAT IS YOUR “S” SCORE?

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The reason why a business existed was to make money in the past decades. For those who wanted their investment to pay off and grow, both the good and bad things that happened to the community surrounding their business were not at the forefront. However, time has changed not only for investors but also how their investment responds to the evolving trends and concerns. A new concept regarding the intangible assets of companies is gaining more and more importance in terms of investments and sustainability. Today, the following three factors play a crucial role in today's investment world: Environment, Social and Governance (ESG). The ESG is an investment philosophy that considers not only the return on investment but also whether the company meets social responsibility standards when making investment decisions.

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Developing a business model by addressing environmental, social, and governance (ESG) factors have become a way to support the financial performance and competitiveness of investments. Investors are trying to create long-term value with environmental, social and management challenges and opportunities in their projects. In this sense, ESG factors have become a fundamental value that strengthens the reputation of companies rather than a temporary trend. The inclusion and examination of ESG issues in the investment process offers investors the opportunity to make a more comprehensive analysis by evaluating potential non-financial risks and opportunities as well as traditional financial analysis.

 

What are ESG Criteria?

Environmental, Social and Governance (ESG) criteria are a set of standards for the activities of a company that socially aware investors use to filter potential sustainable investments. Environmental criteria take into account how a company performs as a guardian of nature. The social criteria examine the way it manages relations with employees, suppliers, customers and the communities in which it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. Investments evaluated by integrating ESG criteria have the potential to increase financial returns, while investments made without taking ESG criteria into account are considered to have a negative impact on financial returns. Commonly used ESG criteria are listed in the table below.

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ESG Factors (Global Compact the Principles of Responsible Investment)

 

• Environmental criteria include the company’s use of renewable energy sources, its waste management program, how it handles potential problems of air or water pollution arising from its operations, and the company’s attitude and actions regarding climate change. It also considers the environmental risks that can affect a company's revenue and how the company manages those risks. For example, a company may face environmental risks due to ownership of contaminated land, an oil spill, its management of toxic emissions at the disposal of hazardous wastes, or compliance with the government's environmental regulations. 

• Social criteria cover an extremely wide range of potential issues. There are various social standards of ESG, but all of them are essentially about social management and relations. One of the key relationships for a company, from the point of view of many socially responsible investors, is the company’s relationship with its employees. In short, social criteria examine human-related factors such as human rights, child and forced labor, community well-fare, stakeholder safe and health.

• Governance is essentially about how a company is managed by those in the top floor executive offices. The corporate governance component deals with the board and company oversight, as well as the stakeholder-friendly and governance-centered attitude. In short, ESG investors analyze the quality of management, board independence, mitigating conflicts of interest, and board diversity.

 

At the core of ESG investing is the basic idea that businesses are more likely to succeed and deliver robust returns if they create value for all their stakeholders– employees, customers, suppliers, and wider society including the environment rather than benefiting only the company owners. Consequently, the ESG analysis examines how companies serve society and how it affects their current and future performance. The ESG analysis goes beyond what the company is currently doing. Considering future trends is of critical importance and should intrinsically include disruptive changes that may have a significant impact on the future profitability of a business or its very existence.

We see these three elements even more important today. In the context of efforts to save humanity from the current outbreak and strengthen business resilience in the future, ESG factors have become even more important.  To update you with trending information, we will be sharing ESG articles with you on a weekly basis. We will introduce ESG factors respectively and continue to publish on ESG applications.

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