ESG Is Not New — But It’s The New Normal
It would be easy to dismiss ESG as just another corporate buzzword like Six Sigma or the open-plan office, but that would be a mistake.
While it's true that business trends come and go, and things that were popular once are now yesterday's news, ESG isn't going away anytime soon. In fact, you can expect it to become even more important in the coming year.
First, what is ESG?
Gartner sums up ESG nicely in its definition:
“Environmental, social and governance (ESG) refers to a collection of corporate performance evaluation criteria that assess the robustness of a company’s governance mechanisms and its ability to effectively manage its environmental and social impacts.”
The first cited use of the word “ESG” was in the 2006 United Nations’ Principles for Responsible Investment (PRI) report, and the term started circulating a few years after that. But while the idea of ESG as we know it today has only been around since the mid-2000s, the roots of this discipline can be traced all the way back to the turn of the 20th century.
A revolution 170 years in the making
As you might have gathered from Gartner’s definition, many of the key concepts of ESG are rooted in the sustainability movement, which first appeared in the 1980s. Sustainability took into consideration both a business’ environmental and social impact.
Before that, there was the “green” movement of the 1960s and 1970s which led to the establishment of the US Environmental Protection Agency (EPA) and the Clean Air Act. And before that, as far back as the mid-1800s, there was the conservation movement that brought us the National Parks and laid the groundwork for future environmental legislation.
Through that lens it's easy to see that ESG is not something new, but an evolution of what's been going on for decades.
Climate change is driving ESG action
Fast forward to today, and ESG issues have taken on a new sense of urgency.
Scientists agree that human-caused climate change is real, and worsening. A highly anticipated report from the United Nations Intergovernmental Panel on Climate Change (IPCC) published earlier this year found that “some of the changes already set in motion—such as continued sea level rise—are irreversible over hundreds to thousands of years.”
Of course, we don’t need a report to tell us that. The physical effects of climate change are all around us, from unprecedented wildfires to intense flooding, droughts, extreme heat, and hurricanes.
Businesses, too, are feeling the effects.
In September, Hurricane Ida shut down 95% of oil and gas production in the Gulf of Mexico. This shutdown could reduce total US oil production by 30 million barrels this year — the worst losses since Hurricanes Katrina and Rita hit the gulf back-to-back in 2005.
Around the world, climate change has disrupted shipping and supply chains, increased insurance costs, and made working conditions more difficult. According to S&P Global Market Intelligence, “80% of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change”.
ESG investing is growing
In total, climate-related weather events are expected to cost businesses $1.3 trillion by 2026. That number has caused many investors to sit up and take notice.
As a result, individual investors, banks, and stock exchanges are increasingly using ESG disclosure as a way to measure investing risks and opportunities.
Today, Bloomberg, Fitch, MSCI, Moody’s, and S&P Global are among the companies that take ESG factors into account in their investment analyses.
Public policy is catching up
Public policy is also cementing ESG as a critical issue for corporations.
The 2020 Carrots & Sticks report by the Global Reporting Initiative (GRI) and the University of Stellenbosch Business School states that the number of ESG reporting provisions issued by governmental bodies has grown 74% over the last four years. Today there are nearly 400 reporting provisions in the 80 countries included in the study. Sector-specific requirements, particularly for financial services and heavy industries, are also becoming more common.
However, it’s important to note that many of these ESG disclosure provisions apply only to large companies, or those listed on a stock exchange. For example, the European Union (EU) has introduced a new Corporate Sustainability Reporting Directive that mandates all large companies issue regular reports on specific social and environmental issues.
Businesses of all sizes are getting on board
Not surprisingly, most major businesses have adopted ESG targets. More than 100 companies have signed The Climate Pledge, a pact to reach the Paris Agreement goal of net zero carbon 10 years early. Others are taking steps to embed ESG at the boardroom level, such as by linking executive pay to ESG performance.
What is surprising, however, is the number of small and mid-size companies that are embracing ESG.
A research report by the Quoted Companies Alliance (QCA) found that more than three out of four (77%) small and mid-caps have a formal purpose statement related to ESG. What’s more, nearly one out of five (18.5%) are using ESG standards, such as the UN SDG, GRI, or SASB.
This is significant given that smaller companies are usually the slowest to adopt new business trends.
Unlike big companies, they don't have the resources to jump on each new fad that comes into fashion. They also don't face as much pressure to do so as their larger counterparts, so they typically only adopt trends when it becomes a financial imperative to do so.
The fact that so many small businesses are getting on board is further proof that ESG is an accepted part of the business ecosystem, in the same way as safety or compliance.
ESG is here to stay
In spite of all this, there are skeptics who still argue that ESG will eventually go the way of the dinosaur. Some point to the next US Presidential election as a potential turning point for ESG priorities.
It doesn’t take a crystal ball to predict that a new administration could bring about significant regulatory changes. However, it won’t change the fact that a growing number of countries — including India, the United Kingdom, and the European Union — have mandatory ESG disclosure regulations. To compete globally, corporations will have to address ESG issues regardless of US policy.
Others argue that once ESG is widely adopted, companies will lose interest and start looking for the next big thing. But that would be like saying that companies are going to lose interest in safety or compliance. They simply can't afford to get bored with ESG in light of the risks to their revenue and reputation.
As our understanding of ESG issues evolves, it may eventually be repackaged with a new name. However, the core concept of environmental, social, and governance (ESG) will continue to be an important issue for the foreseeable future.