The roots of ESG goes back to 2006 when former Secretary-General of the United Nations, Kofi Annan, encouraged large financial institutions to join the ESG Capital Markets Integration Initiative under the United Nations Global Compact. However, ESG factors are becoming increasingly prevalent as a result of the combined demand from the younger/new generation of employees, investors and consumers.
Consumers today prefer companies that incorporate environmental considerations into their products, services, and operations. They want to know whether a company really supports diversity and inclusiveness in the workplace and whether it is managed in a responsible and ethical manner. In a nutshell, customers want to support businesses that share their values, not just produce products, and deliver services.
From investors point of view, a growing number of investors are ensuring that their money is used to support companies that conduct their activities in an environmentally friendly manner. For many, environmental protection – the “E” in the ESG triad of environmental, social (“S”) and business (“G”) governance – is the most important issue.
As far as environmental and climate protection is concerned, companies benefit and suffer. Through focused investments, they can actively contribute to the reduction of harmful emissions and the consumption of natural resources. Concurrently, the risk that they become victims of the climate change is growing. We all remember BP's traumatic oil spill in 2010. This accident testifies to the tangible environmental risks associated with business conduct and how these errors can affect ESG standards. As a result of this disaster, share prices fell and billions of dollars were lost. According to a study conducted by McKinsey (2020), the 2003 heatwave cost the European economy approximately $15 billion. In 2012, the U.S. lost $62 billion from Sandy Hurricane. Climate change has transformed itself into a significant investment risk.
Environmental considerations were once seen as indirect parts of the economic equation, but issues such as climate risk, water scarcity, extreme temperatures and carbon emissions now threaten to slow economic growth. The state of the environment can directly affect the competitiveness of a business. Therefore, environmental factor has become an important element of the new ESG, risk management investment practice and environmental, social and governance opportunities. To understand environmental risks, it is necessary to understand "E" in ESG factors.
The environmental component of the ESG criteria is the performance of an enterprise in managing the resources it uses or allocates to its activities. The company's environmental impact is evaluated by taking into account the following factors: energy consumption in operations, polluting emissions, waste produced, conservation of natural resources and ethical handling of animals. The focus is on the outputs and inputs of an organization. A company's output is made up by what the organization produces and the extent to which it produces it. Organizational inputs play a role in ensuring that the organization has the resources it needs to feed its processes.
The environment does not mean that you only invest in companies that are working on environmental pollution control. Companies are required to consider a number of factors when considering their environmental impacts. This means that you work to engage business with strong policies on waste, climate change, resource use and the provision of eco-friendly products and services. For instance, ESG investors avoid corporations that create or consume too many fossil fuels. Rather, they can focus on manufacturers who produce recycled or recyclable products or rely on renewable energy.
Read our previous article to learn more about the ESG standards and criteria and sign up to our newsletter below to stay informed about ESG practices!
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