ESG EXPLAINED

WHAT IS ESG?

Environmental, social and governance (ESG) is a framework used to assess an organization's business practices and performance on various sustainability and ethical issues. It also provides a way to measure business risks and opportunities in those areas. In capital markets, some investors use ESG criteria to evaluate companies and help determine their investment plans, a practice known as ESG investing.

While sustainability, ethics and corporate governance are generally considered to be non-financial performance indicators, the role of an ESG program is to ensure accountability and the implementation of systems and processes to manage a company's impact, such as its carbon footprint and how it treats employees, suppliers and other stakeholders. ESG initiatives also contribute to broader business sustainability efforts that aim to position companies for long-term success based on responsible corporate management and business strategies.

WHAT IS ESG INVESTING?

Environmental, social, and governance (ESG) investing refers to a set of standards for a company’s behavior used by socially conscious investors to screen potential investments.Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example. 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.

ENVIRONMENTAL

Environmental issues may include corporate climate policies, energy use, waste, pollution, natural resource conservation, and treatment of animals. ESG considerations can also help evaluate any environmental risks a company might face and how the company is managing those risks.

Considerations may include direct and indirect greenhouse gas emissions, management of toxic waste, and compliance with environmental regulations.

Examples of the E in ESG criteria could be investing in companies that:

  • Publish a carbon or sustainability report
  • Limit harmful pollutants and chemicals
  • Seek to lower greenhouse gas emissions and CO2 footprint
  • Use renewable energy sources
  • Reduce waste

SOCIAL

Social aspects look at the company’s relationships with internal and external stakeholders.

Does it hold suppliers to its own ESG standards? Does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there? Do workplace conditions reflect a high regard for employees’ health and safety? Or does the company take unethical advantage of its customers?

Socially responsible investing (SRI) is an investment strategy that highlights this one facet of ESG. SRI investors seek companies that promote ethical and socially conscious themes including diversity, inclusion, community-focus, social justice, and corporate ethics, in addition to fighting against racial, gender, and sexual discrimination.

Examples of the S in ESG criteria could be investing in companies that:

  • Operate ethical supply chains
  • Avoid overseas labour that may have questionable workplace safety or employ child labour
  • Supports LGBTQ+ rights and encourages all forms of diversity
  • Have policies to protect against sexual misconduct
  • Pay fair (living) wages

GOVERNANCE

ESG governance standards ensure a company uses accurate and transparent accounting methods, pursues integrity and diversity in selecting its leadership, and is accountable to shareholders.

ESG investors may require assurances that companies avoid conflicts of interest in their choice of board members and senior executives, don't use political contributions to obtain preferential treatment, or engage in illegal conduct.

Examples of the G in ESG criteria could be investing in companies that:

  • Embrace diversity on the board of directors
  • Embrace corporate transparency
  • Appoint someone other than the CEO as chair of the board
  • Stagger board elections

WHAT DOES ESG MEAN FOR A BUSINESS?

Adopting ESG principles means that corporate strategy focuses on the three pillars of the environment, social, and governance. This means taking measures to lower pollution, CO2 output, and reduce waste. It also means having a diverse and inclusive workforce, at the entry-level and all the way up to the board of directors. ESG may be costly and time-consuming to undertake, but can also be rewarding into the future for those that carry it through.

ESG AND REAL ESTATE

Once upon a time, real estate embodied the epitome of capitalism. The trend, however, is growing quite the opposite way. The application of ESG standards on real estate (notably by governments and developers in many developed countries) has shown that this asset class is also relevant when these guiding principles are being applied.

Awareness is growing that real estate can have a significant social impact either through the form of rehabilitation of public spaces (indirectly attributing value to existing real estate), affordable housing, social housing, and care centers, or through an environmental focus investment on new buildings such as green buildings.