What does ESG stand for?

Published 26th March 2023

ESG is a relatively new term that first started being used in the mid-2000s. With it being so new, not many people know what ESG stands for, but as awareness for sustainability issues have been on the rise and sustainable practices have become more embedded into core business strategies, it’s fast becoming a common business phrase.

Investors are increasingly looking for ESG information when considering potential investments, since ESG factors affect the financial value and long-term profitability and success of a business. Businesses have therefore been taking sustainability considerations seriously and making sure that they do not fall behind and lose out on investors and other opportunities.

So, what is ESG? ESG is only a small part of the broader concept of ‘sustainability’ – you can read more about this in our recent article – ESG is an acronym which stands for Environmental, Social and Governance. These are the criteria in which a company can measure the impact ESG factors have on the business and make changes towards more sustainable practices.

The breakdown of the three factors that comprise ESG - that give ESG meaning - are as follows:

The E in ESG

The ESG environmental element deals with how a company interacts with the environment, including how climate change impacts the company and what measures have been taken to minimise its negative effects. This includes looking at carbon emissions, air and water pollution, energy efficiency, plastic use and waste management, among other things.

Examples of sustainable environmental practices that a business can adopt include reducing energy use and switching to renewable energy sources, using biodegradable or recycled.

The S in ESG

The ESG social criteria refers to the connection that the company has in its own workplace and wider society, including its relationship with its employees, suppliers, customers and communities. Looking at promoting equality, preventing supply chain abuses, ensuring products are safe and helping communities are all relevant for the social factor.

Examples of sustainable social practices include ensuring that supply and production chains are not linked to human rights abuses, providing training and support to workers, promoting equality in the workplace, and investing in local community projects such as education and healthcare.

The G in ESG

Finally, the ESG governance part looks at aspects of a business’ culture, structure, policies and procedures. This includes, for example, shareholder rights, the accurate reporting of financial performance and business strategy, being open about executive pay and board composition, and ensuring there is no bribery and corruption.

Examples of positive sustainable governance practices include accurate and transparent information disclosure to shareholders and investors, employing measures to prevent bribery and corruption, and ensuring accountability for risks and performance by senior management.

When did people start using ESG?

About a decade ago, few people would know how to answer the question, ‘what does ESG stand for?’ Countries only started to pay real attention to climate change and other sustainability issues such as biodiversity loss, social inequality and poverty in 2015. This followed on from pledges made by governments under the Paris Agreement and the adoption of the Sustainable Development Goals by UN member states. Since then, businesses have become more conscious of sustainability issues and how it affects them. As such, ESG has grown in prominence.

Although ESG reporting is not mandatory in all countries, governments around the world are responding to demands for high-quality corporate reporting on ESG information and improved disclosure. Many governments and market regulators have introduced more detailed frameworks and regulations for sustainability reporting and mandating sustainability-related disclosures, and it is likely that this regulatory landscape will only continue to grow with time.

Today, according to management consulting company McKinsey & Company, more than 90 percent of S&P 500 companies and about 70 percent of Russell 1000 companies publish ESG reports in some form. These statistics showcase how important ESG reporting has become for listed companies.

ESG practices

It makes sense for companies to integrate sustainability considerations into their operations - not only to help build a better and more sustainable future, but there are also valuable financial and non-financial benefits for companies to pursue sustainability efforts. This includes attracting more investors and growing capital, risk management and compliance with regulatory developments, strengthening profits and longevity of the company and improving the company’s reputation. Because of the positive implications, investors today are increasingly eager to include companies with well reported and transparent ESG information into their portfolios. For the same reason, companies that adopt a more sustainable approach are often better able to attract customers and employees.

ESG practices can also cut costs and increase revenue. Many studies have shown a positive relationship between businesses that incorporate sustainable activities and improved financial performance. An example of this would be insulating a company’s premises to keep in the warmth or switching to LED lighting, both of which reduce energy use and therefore save money. Reducing waste by cutting down the amount of material used in packaging also saves costs. Another example would be keeping production machines well-maintained and replacing worn parts and old equipment to reduce the risk of labour accidents and workers’ absenteeism.

However, one of the issues facing ESG is an inconsistency in how it is applied. There is no standardised approach to how different ESG metrics are assessed. Several financial firms have their own ratings and scoring systems, with differences in weighting and methodology approaches. Meanwhile, companies applying ESG practices vary greatly in the challenges that they face, depending on factors like which sector they operate in and where in the world they are based. They are rarely able to address all ESG concerns at once.

One of the keys to the success of ESG is materiality - which is a process that companies can go through to assess ESG factors that are most relevant to them in their particular circumstance and help priorities these issues. However, different reporting frameworks have different interpretations and recommendations on how the concept of materiality should be applied. Institutions such as the Sustainability Accounting Standards Board (SASB), the Global Reporting Initiative (GRI), and the Task Force on Climate-related Financial Disclosures (TCFD) are working on defining this and forming standards for companies to use. The key for investors is being able to find transparent, comparable and qualitative information on companies they wish to invest in.

There are also concerns over ESG being used deceptively, with disclosure lapses or more seriously, accusations of ‘greenwashing’ or the overstating of ESG capabilities. But these difficulties should not hold ESG back. They are part of the learning process.

The ultimate value of ESG practices will depend on whether they encourage companies to drive real change for the common good, or merely be used as a box ticking exercise to comply with regulations or meet stakeholder demand. Companies should not view ESG practices as merely fulfilling a mandatory reporting requirement and the of end sustainability considerations, but rather as a steppingstone to leverage and build a comprehensive sustainability strategy to remain competitive and thrive in the long term. If it is applied in the right way, with companies focusing on where they can really make an impact, it can help build a fairer, better, cleaner, more resilient business and in turn, a fairer, better, more resilient world.

How can we help you?

As sustainability is pushed to the top of the agenda. Corporates, investors and financial institutions require environmental, social and governance (ESG) plan and a path to achieve it.

We help leaders put together these ESG plans and work with them to implement them. We diagnose their current sustainability issues, establish baselines, define their goals and design the execution plan.

To find out more about how we can help with your sustainable finance strategy, get in touch.