Why do certain investments perform better than others? Why do certain startups seem to always outperform and get ahead of the cohort? The answer has three letters, and it is ESG. Whether you are an investor or a company, big or small - Environmental, Social and Governance (ESG) reporting and investing, is the framework to catch on if you want to stay up to speed with the market (and your bill).
In that sense, ESG is not only a framework that financial institutions and investors have to report on; it is also on the radar of employees, regulators and everyone involved in the ecosystem. Why? Simply because phenomena such as the coronavirus outbreak and climate change make us realise that we are not masters of our planet but rather stewards of nature. ESG is taking on an even greater significance in light of recent events: companies have the responsibility and resources to accomplish positive climate action, building a more sustainable, resilient future and “putting money where their mouth is”.
It is essential to state that to meet the goal of limiting the global temperature increase to 1.5°C, $90tn of investment is needed by 2030. Now, let’s dive into the ESG topic and the great importance that it has for companies and investors.
ESG reporting for investors: the whitepaper
To help investors, financial institutions, and companies understand better the underlying criteria to implement and report on them, we designed a data-based document on ESG reporting. Download the form below and access this exclusive ESG resource for free.
What is ESG?
By definition, ESG reporting is the disclosure of data explaining a company's impact and added value in three areas: environment, social and corporate governance. ESG is the umbrella term for sustainable and responsible finance components. It is a framework considering environmental, social and governance factors alongside financial factors in the investment decision-making process. It is also a process to assess which companies perform/score on each of the factors: E-S & G, and determine if it is a viable investment.
“ It’s not just 5 percent of your money you give away that matters. What you do with the other 95 per cent is almost more important.”
Darren Walker - President of the Ford Foundation
What environmental mean in ESG?
Environmental (E) assesses how a company performs as a steward of nature. It analyses how its activities impact the environment and manage environmental risks. It includes both direct operations and across the supply chain. For example, resource scarcity and management, natural resources preservation, animal treatment and greenhouse gas emissions.
What social mean in ESG?
Social criteria (S) examines the strengths and weaknesses of how a company manages relationships with employees, suppliers, customers, and the communities where it operates. For example, these criteria include working conditions, operations in conflict regions, health and safety, employee relations and diversity.
What governance mean in ESG?
Governance (G) deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights. Investors want to know if they can trust the company and what kind of decisions are taken behind closed doors. It includes executive pay, gender equity / equal pay, bribery and corruption, and board diversity.
Who cares Wins: The importance of ESG for companies and investors
The practice of ESG investing began in the 1960s. ESG investing evolved from socially responsible investing (SRI), which excluded stocks or entire industries from investments related to business operations such as tobacco, guns, or goods from conflicted regions. The term ESG was coined in 2004 by former UN Secretary-General Kofi Annan and resulted in 2005 with the first study, “Who cares Wins”, developed jointly with the world’s largest institutional investors and banks.
Now, ESG is rapidly growing and evolving, as many investors look to incorporate ESG factors into the investment process. As a fact, the ESG market is already set to double this year. Also, the Portfolio Decarbonization Coalition, a United Nations-sponsored group of 27 primarily European institutional investors and asset managers controlling $3.2 trillion in assets, has committed $600 billion to fund green projects and investments.
On the legal side, European regulations are pushing for robust implementation of ESG factors within the financial sector and everywhere else. The ESG framework is pushed within the EU as it is a mechanism that will support the green deal and ensure the implementation of a more sustainable economy. “ESG is likely to play a bigger role in how companies are assessed, not only by investors but by consumers and stakeholders”, explains Nathan Bonnisseau, Co-Founder & CMO at Plan A. “The numbers reflect a growing awareness that companies must manage their environmental impact in innovative ways in order to remain successful. Sustainability is the new ideal, and the development of sophisticated methods of evaluating ESG activities and effect, is the key to attaining it,” he adds.
Where does the pressure come from?
The mounting pressure to implement ESG factors comes from legislators, investors and the business ecosystem (e.g media, consumers, stakeholders, customers). To remain attractive as an employer or a brand, companies have to perform well on ESG. As an example, 49% of millennial millionaires make their investments based on social factors. Therefore, it is essential for VC’s, startups and tech companies to anticipate the law.
Looking at how the wind is turning around the regulatory framework in the financial sector, ESG might become mandatory for all organisations - if assets managers must comply with ESG reporting, you are sure that they will pass under scrutiny their entire portfolios - including numerous startups. Here are the regulations to keep an eye on:
- The European Union SFDR (Sustainable Finance Disclosure Regulation) entered into force on March 11, 2021. It imposes mandatory ESG disclosure obligations for asset managers and other financial markets participants with substantive provisions.
- The EU Sustainable Finance Action Plan: A significant policy objective by the European Union to promote sustainable investment across the continent. Parts of it are effective from March 2021. The aim is to reorient capital flows towards sustainable investment and away from sectors contributing to climate change, such as fossil fuels.
- The EU Taxonomy: The European Union Taxonomy is arguably the most ambitious text aiming to give a non-financial overall score covering all facets of sustainability, from ESG to biodiversity and pollution treatment. The EU taxonomy is a classification system establishing a list of environmentally sustainable economic activities. For investors, companies and financial institutions—the regulation defines which economic activities qualify as sustainable and evaluate their environmental performance. From January 2022, financial market participants are required to report how and to what extent their financial products align with the EU Taxonomy, a framework to classify environmentally sustainable economic activities
How ESG creates value?
Since 2019, European investors poured €120 billion into sustainable investment options, demonstrating that something interesting is stirring: VCs and investors are increasingly interested in how startups are scoring on their ESG policies and practices. There are many scenarios in which the pressure to implement ESG in your company comes from. For example, suppose you are a startup founder and looking actively for funding - you will have better chances to convince investors if your company has already implemented ESG policies and performs well on these factors.
On one hand, it has been demonstrated that companies performing on ESG practices have higher financial growth and optimisation, lower volatility, higher employee productivity, reduced regulatory and legal interventions (fines and sanctions), top-line growth, and cost reductions. On the other hand, companies that performed poorly on ESG noticed a higher cost of capital, higher volatility due to controversies and other incidences such as labour strikes, fraud accounting and other governance irregularities. So you rather jump on this train if you do not want to be left behind.
Why is it inevitable?
There is an increasing awareness that ESG may become compulsory or mandatory. For companies to stay ahead of regulations, competition and unleash all the benefits of ESG, they must integrate this framework at the core of their DNA. In another perspective, organisations that fail to comply with environmental or social factors may end up struggling to deal with regulatory, legal or reputation issues at a later stage.
What is the best course of action? Follow a methodology that reflects sustainability and ESG. It is never too late to start: it is easier and faster to incorporate ESG from the start, making the next generations of unicorns or Fortune 500 businesses more diversified and equal, more concerned with the health & welfare of their people and positively impacting their communities and the environment.