What is ESG?
Environmental, social, and governance, known as ESG, is a set of standards that guides a company’s behavior and decision-making process. ESG is used to appeal to socially conscious investors and to analyze potential investments and their impact on the environment. Each of the three categories of ESG includes:
- Environmental – This category considers the company’s impact on the environment by addressing major issues, such as climate change, pollution, and carbon emissions. ESG considerations also pinpoint environmental risks and solutions to minimize those issues.
- Social – This category covers the internal commitment to improving diversity, supporting different cultures, promoting employee satisfaction, and creating strong workplace conditions. Organizations with happy and healthy employees are more likely to be considered a good investment.
- Governance – This category ensures the business is following the proper accounting standards, maintaining compliance with regulatory agencies, and showing accountability in leadership. Investors want companies that adapt to changing regulations and have committed to strong workplace standards.
Each of these categories appeals to a certain type of investor. By maximizing all three factors, your financial service company is more likely to achieve the necessary funding from outside investors and generate a strong customer base.
Why is ESG Important?
ESG is becoming increasingly important as consumers and investors move toward reducing carbon footprints and sustainability. In fact, studies show that 88% of consumers will be more loyal to a company that prioritizes social and environmental issues. Developing a loyal customer base is vital for the long-term success and scalability of your company.
Another benefit of ESG is the environment. It not only brings awareness to different environmental issues that exist, but it also encourages other businesses to implement sustainable policies and practices. As ESG grows in prevalence, more businesses are likely to adopt sustainability measures to remain competitive.
ESG also benefits organizations when they need outside funding through investors. Data shows that sustainably invested assets grew 42% between 2018 and 2020, capturing $51.1 billion in 2020. Investors want to make a positive impact on the environment. What better way than to vote with their dollar? The inability of your organization to adapt to changing investor preferences towards expanded ethics and sustainability can hinder growth when you can’t obtain the necessary funding.
When an emphasis is placed on ESG, the workplace becomes more inviting for employees, promoting high retention and low turnover rates. This helps companies maintain the needed labor pool to sustain operations and grow. Moreover, clear sustainability agendas can attract new talent to your business by generating a sense of pride. Younger generation preferences have shifted towards companies with a strong commitment to the environment, social factors, and compliance.
ESG is also important for compliance. According to recent studies, the average cost of compliance is $10,000 per employee. The cost of noncompliance is much more significant, with the FINRA imposing $61 million in fines in a single year. ESG prioritizes compliance with all regulatory agencies, leading to reduced costs in fines and penalties.
How is ESG Scored?
ESG scores are created by third parties that have a specific set of methodologies used to analyze companies. Unfortunately, the scoring methods are not streamlined, meaning you can get different results depending on the firm you hire. This makes it important to fully vet the reputation and scoring methods of a company before you hire them to analyze your organization.
Nevertheless, the goal of ESG scores is to give an overall picture of the organization’s performance in each of the three categories. Third-party firms arrive at their conclusions by conducting interviews with employees and members of management, evaluating corporate disclosures, reviewing public information on the company, and understanding recent initiatives. In addition, firms may analyze the following information:
- Environment – published sustainability reports, use of harmful chemicals, amount of greenhouse emissions, different renewable energy sources, and waste reduction measures
- Social – ethical supply chains, avoidance of overseas labor, prevalent workplace misconduct policies, paying of livable wages, and supporting different diversity groups
- Governance – diversity throughout the board of directors, corporate transparency policies, whistleblower provisions, and independence in the board of directors
Receiving a good rating is important to appeal to various investors and consumers with environmentally and socially friendly initiatives.
How Can Companies Improve ESG Initiatives?
The goal of an ESG score isn’t just to attract new investors and consumers but also to understand where your business might fall short. One way to improve an ESG rating is to implement smart building technology that tracks efficiency and waste. Smart building technology comes with the capabilities to manage the temperature for energy efficiency, improve workers’ conditions, and reduce waste.
In addition, gaining feedback from investors, employees, and consumers on areas that they want to see your organization improve is important. For example, investors might like the concept of your business but aren’t impressed that the board of director terms aren’t staggered. Understanding this information allows your business to enact tangible change.
Employee feedback is essential to improve workplace conditions. You may think that your organization is meeting the needs of employees, but this isn’t always the case. Maybe you find that employees want more paid holidays or want to use a hybrid work schedule to add to flexibility. Whatever the case, meeting the social requirements of ESG relies on communication with your employees.
A top factor that contributes to a low ESG rating is the carbon footprint of your company. If you have a high carbon footprint, you are more likely to struggle with the overall environmental impact your business has. Find ways to promote automation or utilize sustainable products. For example, if you consistently deliver monthly statements to your customers, you are generating high waste. You could consider implementing a small incentive for customers to switch to online statements, reducing your carbon footprint.
How Does ESG Impact the Financial Service Sectors?
ESG has a direct impact on the financial service sectors. For one, banks, insurance companies, and wealth management organizations need to find ways to reduce their carbon footprint, appeal to employees, and remain in compliance with regulators. This is done by implementing effective ESG solutions.
Financial service industries must prepare as consumer and investor demand continues to move toward sustainability and ethical considerations. This could be reducing the use of paper in consumer statements or adding diversity measures into the workplace. Finding the right solutions for your financial service business relies on understanding what your target consumers and investors are requesting.
The trends over the past few years support the growing need for businesses to adapt to ESG movements. Knowing the next steps and the impact on your business can seem daunting, which is why Naehas is here to help. Reach out today to schedule a consultation with one of our team members.