Finserv Glossary


What is Environmental, Social, and Governance (ESG)?

Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls, and shareholder rights.

In addressing major trends in compliance, a Forrester Vice President and Principal Analyst, who participated in a high-level discussion with a Naehas Senior Director prior to an industry roundtable, noted an increasing desire by individuals to work for compliant and purpose-led enterprises. He noted that compliance, i.e. Environmental, Social Governance compliance as a primary example, is one of several aspects of a company that employees and customers now see as more important, according to research conducted by the global consultancy.

Commonly referred to as social investing, ESG provides a framework for greater transparency, greater efforts and greater good, as described by The Alva Group, which notes that this social accountability, or corporate citizenship, is largely voluntary, broad and self-regulated. ESG centers around financial risk and returns. ESG criteria are a group of standards used by socially conscious investors to screen investments, and generally quantifiable, as ESG incorporates scores, ratings, and targets that are set and reported upon.

Investors are increasingly applying these non-financial factors, such as Environmental, Social and Governance (ESG) as part of their analysis process. This helps to identify both risks and opportunities. ESG metrics are not commonly part of mandatory financial reporting, though companies are increasingly making disclosures in their annual report or in a standalone sustainability report. Many mutual funds, brokerage firms, and advisors offer products that employ ESG criteria. ESG criteria can also help investors avoid companies that might pose a greater financial risk due to their environmental or other practices.

Environmental, Social and Governance (ESG) performance is now an essential metric for capital markets, according to Sphera, which provides ESG performance and risk management software, data and consulting services. It reports that investors are increasingly focused on climate and ESG-related disclosures and investments. Companies with strong ESG performance have higher returns on their investments, lower risks and better resiliency during a crisis. As noted by Sphera, a survey by BlackRock (of which Sphera is a portfolio company) found that 88% of investors said that a top sustainability portfolio concern for them is climate-related risks. They also say that they plan to double their ESG assets in five years.

Companies committed to ESG criteria benefit from technology that supports automated management of voluntary disclosures, which allows for accuracy, transparency and auditability.