ESG, short for Environmental, Social, and Governance, refers to a set of criteria that companies use to assess their performance in terms of sustainability, ethical practices and corporate social responsibility. ESG can have a significant impact on a company’s long-term success because by prioritizing sustainability and ethical practices in decision-making processes, companies can improve their reputation among consumers and investors, and they can also be better positioned for regulatory changes related to environmental or social issues. In addition, companies that prioritize ESG factors may have a lower risk profile than those that do not. For example, a society that invests heavily in renewable energy sources may be less sensitive to fluctuations in fossil fuel prices or carbon taxes. There is a noticeable trend, especially among young consumers, where they choose products and producers who care about sustainability.
Regulatory Framework for ESG
The European Union has established a complete regulatory framework for ESG reporting. The Corporate Sustainability Reporting Directive, (CSRD) accepted on November 10, 2022, represents an EU regulation that requires all large companies to regularly and transparently publish information on the effects of their activities on the environment and society and on the sustainability risks they may be exposed to. Around 50,000 companies will be covered by the new regulation. CSRD is introducing important changes, and one of them is that the taxpayers will have to prepare their reports according to European Sustainability Reporting Standards (ESRS).
The first sustainability reports prepared according to ESRS standards will be published in 2025 for the financial year 2024.
The first to report according to European standards will be the current reporting entities of the Non-Financial Reporting Directive, i.e. public interest entities with over 500 employees. A year after that, this obligation will apply to all large entities, and as of 2028, all SMEs listed at the stock market will report on sustainability as well.
ESG Elements
Environmental factors – the first factor of ESG is related to the direct or indirect impact of business on the natural environment, i.e. how the company helps to preserve the health of the natural environment. These include issues such as climate change, environmental pollution, exploitation of natural resources, waste management, greenhouse gas emissions, deforestation, and energy efficiency.
Social factors – the second factor is the social factor. This includes issues related to human rights, labor practices, diversity and inclusion policies and community engagement. Companies are expected to treat their employees fairly and to provide them with a safe working environment, working conditions, health and safety.
Management factors – the third factor is management. This relates to issues such as executive compensation and pay and remuneration policies and practices, diversity and independence of board members, shareholder rights and transparency in financial reporting. The companies are expected to uphold the high ethical standards when it comes to management practices.
Why ESG
The reality is that more and more investment funds are using ESG factors to decide which businesses to support, and this is a trend that is likely to continue in the future. Socially responsible investors use ESG criteria to check the behavior of companies before investing in them In order to compete successfully, companies must demonstrate that they understand and have adopted ESG principles. If you are already doing business at an international level – or plan on doing so – a good ESG strategy can help improve the value of your products and services, while at the same time reducing the negative impacts of your company on people and the environment. ESG is an important factor for companies when making decisions that can affect their long-term success. By prioritizing environmental, social and governance factors, companies can improve their reputation, reduce their risk profile and be better positioned to adapt to regulatory changes. It is clear that the importance of ESG will increase in the years to come. Switching to an ESG strategy is not easy. A team of experts should be behind its implementation.
Advantages of ESG strategy
Some of the more important advantages of ESG strategy are:
- Gaining access to capital – companies that incorporate ESG into their corporate culture and operations, whether in risk management, business activities or social and environmental issues, are more likely to attract capital investment (often at a lower cost) than those that do not. This, of course, increases the long-term value of the company
- Driving innovation and growth: When you understand your risks and what drives them, you can find ESG-based solutions. This can drive a lot of innovation as you are forced to explore new and better ways of doing business. Such innovations can also open up new avenues of growth.
- Increasing business resilience: businesses must be able to anticipate and prepare for change, then adapt to circumstances in a way that provides the greatest chance for long-term progress.
- Risk management: effective use of ESG principles can help you manage risk. Let us assume that you source key raw materials for your key products from a region affected by climate change. By using environmental ESG criteria, you can better understand the evolving climate risks for your business and diversify your inputs
- Attract and retain customers: putting ESG principles into practice can help you acquire new and retain long-term customers. Studies show that consumers are looking for sustainable brands and prefer to buy from companies with strong environmental and social records.
- Recruitment and retention: Younger people are particularly aware of social and environmental issues. As a result, they tend to prefer ESG-aware employers when looking for work. If you have strong ESG values and openly demonstrate them, you will tend to hire better employees and retain them more effectively.
- Better adaptation to the regulatory environment: The regulatory environment is evolving rapidly and each jurisdiction is developing its own rules. Having a clear ESG strategy can help you better adapt to regulations governing the markets in which you operate.