What is ESG and Why is it Important?

Gavin Smith   15 June, 2022

What is ESG?

ESG measures how a company integrates Environmental, Social, and Governance practices into their business and it is changing the approach investors use when viewing their portfolios. Investors are not only focusing on financial return but also considering the societal impact of a company.

Companies that specialise in ESG ratings give investors more insight into how much risk the company has and how sustainable it will be as a business. This may be with regards to their adherence to regulations and frameworks, sustainable growth strategies or good governance.

Why is ESG important?

The popularity of ESG investing has been on an upward curve over the past decade and since the pandemic, it has seen a meteoric rise. “Between May 2005 and May 2018, ESG was mentioned in fewer than one percent of earnings calls (when a company discusses their financial results over a period), but by May 2021 it was mentioned in almost a fifth of earnings calls” (Source: Financial Times 2022). This nuanced way of investing is seemingly the talk of the town.

It has taken the financial industry by storm, and with the changing global economy it has become increasingly important for investors to know that they have shares in companies with sustainable business strategies. This is important because, due to societal and environmental pressures such as global warming, civil unrest, and workplace inequality, investors want to know that their companies are making a positive impact on society and that they will be sustainable to survive in the long run.

How ESG is useful for investors?

Return on investment is a crucial factor on an investor’s mind when deciding where to divvy their money. With the lack of reputable information on ESG, many investors think that investing in ESG funds is a sacrificial endeavour due to the notion that gaining more societal impact means you will lose financial return.

On the other hand, there is a growing recognition that companies who are putting the frameworks in place to strive for a sustainable business are seeing an increase in financial return. Furthermore, these companies will be better suited to deal with change and manage risks in our economy. This is prompting investors to look closely at ESG funds, because a high ESG rating is becoming a more influential factor for investment.

What do the ratings mean?

There are two very different ways that investors use ESG ratings. Firstly, a company may want to assess the impact of their operations on their local communities and the environment. Secondly, ESG ratings can be used by financial institutions to interpret if a company is using sustainable business practices and to assess the company’s investment potential. These ratings are used to assess risk for investors. If a company has a low ESG rating, investors may be more reluctant to invest in it compared to a company with a higher ESG rating, showing that they have a robust sustainable business strategy and may be more suited to deal with risk in the future.

Regulations are being set in place for businesses to disclose their practices through regulations such as the EU Taxonomy Regulation or Sustainable Finance Disclosure Regulation (SFDR). These regulations put pressure on businesses to be more conscious about their environmental and societal impact for a sustainable future.

There is a major paradigm shift happening in the ESG space where investors are rushing to find the best ways to identify a company’s risk through the ESG metrics. Investors can mitigate these risks by using ESG ratings to find the best companies with practices that align with their values and goals.

C2 provides clients with risk intelligence that will help them identify which company's to invest in so that they are making a positive societal impact and they are investing in businesses that will be sustainable in the future. 

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