The roots of ESG (Environment, Social and Governance) emerge from Socially Responsible Investing, where money isn’t put in companies that engage in environmentally and socially irresponsible practices. The first instance of SRI dates back 200 years where the Methodist movement protested against investing in companies that made weapons, tobacco etc. A similar movement took place in the 1960s in the light of the Vietnam war. The difference between SRI and ESG lies in the fact that investing based on ESG criteria is considered to make financial sense as well and is not solely tied to a moralistic stance against unethical businesses. This view came to light with the UN PRI report of 2006 which consisted of the Freshfield Report and “Who Cares wins”. The term ESG was first used in the latter and the first highlighted that ESG criteria must be incorporated in financial evaluations. The PRI now has 1600 members representing assets worth over $70 trillion and ESG integration is seen as a part of fiduciary duty with many exchanges mandating ESG disclosure.
ESG investments accelerated in 2013 and reports indicate that between 2014–16, companies that performed well on ESG parameters realized better financial results as well. ESG compliance is going to become increasingly important as the effects of the climate crisis are felt and accepted more. The numbers already back this hypothesis. ESG commitment has increased by 41% between 2014–16 amounting to $8.4 trillion worth of assets according to the GSIA and the demand for ESG analysts in the job market has boomed. ESG has also manifested as ESG-induced divestments and the threat of these can be instrumental in making companies take sustainability seriously. For example, the Rockefeller Fund decided to reduce their exposure to coal and tar due to the threat of divestments and the availability of fossil-free funds. They also decided to examine their investments in areas of high fossil-fuel exposure. However, the downside of divestments is that after a divestment happens there is no incentive for the company to change to greener processes.
Other than the push from investors, companies will have to take ESG seriously for many more reasons as:
- it starts reflecting customer demand. It will be difficult to avoid sustainability in 3/5 year plans from now.
- alternatives exist. Today, renewable energy is becoming increasingly as competitive as fossil fuels.
- climate risk will pose newer and more frequent natural threats. ESG Due-diligence will help in identifying potential threats.
- government regulation will increase. For instance, the European taxonomy for environmental sustainability was published in 2019, propelling companies to comply to new environmental standards.
- Instances of sustainable activism in the private sector are going to rise. For example, Shell announced that its going to announce a C02 emissions target for themselves.
- investors are looking for companies that are equipped for the future given the limitations climate change is going to throw at them.
The greatest barrier currently that is preventing ESG compliance to be the norm is the lack of data. Investors and governments aren’t able to go all-out and companies are struggling to adopt low-carbon processes due to a very fragmented information base available to these stakeholders. The ESG ecosystem involves investors, governments, international regulators and data providers, where the data providers are going to be the backbone of this ecosystem, fuelling all other members’ decisions.
Investors decisions will be influenced by government and international regulations and these regulators will also rely on increased ESG investment to actualise some of their goals; Companies will have to meet investor expectation as well as comply with government policies. Scientists, data scientists, space agencies and governments will have to work towards providing higher resolution data leveraging satellite imaging, AI etc. The government must prioritise aiding these efforts as the requirement for high-quality information is going to become imperative to mitigate climate-change disasters.