ESG standards are becoming an essential component of companies that are looking to attract investment, appeal to the larger public, attract top talent and improve long-term profitability.
- According to McKinsey & Company and Investopedia, ESG standards are defined across three key areas: (1) environmental, (2) social and (3) governance criteria.
- Environmental criteria examine how a company performs as a "steward of nature," such as its waste production, resource utilization, carbon emissions and other impacts on the environment.
- Social criteria consider how a company manages its relationships with stakeholders (e.g., customers, employees, suppliers, communities), and can include discrete factors such as diversity and inclusion.
- Finally, governance criteria refer to a company's self-governance or internal system of "practices, controls and procedures," such as executive pay standards, audit protocols and shareholder rights.
- Notably, the three components of ESG are inextricably intertwined, given that social and environmental factors often overlap, and there are invariably governance concerns underpinning both areas.
- Forbes recommends that all businesses start their ESG journey by identifying three to five measurable ESG criteria that are appropriate for the specific company and industry.
- According to Bank of America, this early process of identifying the key facets of a company's ESG program should begin with obtaining feedback from key stakeholders, such as employees, consumers, investors and public officials.
- As part of this process, companies should also consider benchmarking their proposed ESG framework against their peers through ranking organizations such as the Global Reporting Initiative (GRI), the Sustainability Accounting Standards Board (SASB) and the Global Initiative for Sustainability Rankings (GISR).
- Similarly, Forbes recommends that the general counsel or IR leader should research and address any key ESG criteria that relevant ESG funds or ETFs are using to evaluate investment opportunities.
- Finally, the large majority of experts including Forbes, Bank of America and Nasdaq highlight the importance of establishing and announcing metrics by which a company will measure its ESG performance.
- Failing to do determine and publish which financial and non-financial metrics will be used to evaluate the success of an ESG program not only undermines the ability to track and manage its progress, but can lead to public scrutiny and claims of "greenwashing."
- A preponderance of experts (e.g., McKinsey & Company, Forbes, Investopedia, Nasdaq, Bank of America) highlight the "emerging zeitgeist" and "meteoric rise" of ESG-oriented investing as one of the most significant factors involved in corporations choosing to integrate ESG into their organizations.
- Specifically, a strong ESG program increasingly helps attract large pools of capital amid the growing social, governmental and consumer attention on the larger impact of corporations.
- Moreover, institutional investors such as Trillium Asset Management are increasingly incorporate ESG metrics when evaluating (and excluding) potential investment opportunities, with over 50% of investors now considering ESG when making an investment decision.
- Secondly, ESG initiatives are becoming increasingly attractive to companies because they have been demonstrated to help strengthen corporate brands as well as attracting top talent, according to Forbes and Bank of America.
- The large majority of the general population (86%), as well as Millennials (87%) and Generation Z (94%), believe that companies should address ESG issues, and research indicates that a company's "record for socially responsible behavior" is now a key consideration for individuals when buying a company's products or considering joining a company as an employee.
- In addition to these external ESG factors, recent research by McKinsey and Company also indicates that ESG programs directly "link to cash flow" within corporations in five key ways: (1) top-line growth, (2) cost reduction, (3) preventing regulatory/legal issues, (4) supporting employee productivity and (5) optimizing investment/capital spending.
- Overall, the McKinsey and Company research suggests that a strong ESG program is highly correlated with corporate value creation, as evidenced by stronger equity returns, higher credit ratings, and lower loan and credit default swap spreads.
Oil & Gas Considerations
- Experts such as Investopedia and Bank of America highlight ESG as a particularly relevant subject within the oil and gas industry, given that the industry is central to the growing focus on climate change and sustainability, and has been known for ESG disasters such as BP's 2010 oil spill.
- As such, companies in the oil and gas industry can use ESG programs to signal that they do not engage in the long term "risk factors" that investors are increasingly looking to avoid, but rather are working to address growing social concerns about the energy industry and the environment.
- For example, Forbes suggests that a fracking company could measure the impacts of its clean water and waste management processes on natural resources as a means to not only improve its ESG performance, but share that commitment with external stakeholders.