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

The United Nations’ Sustainable Development Goals are 15 goals outlined by the United Nations Member States, which provides a series of objectives designed to help create peace and prosperity for the people of the planet. No matter the size of the business and regardless of the industry, all companies can contribute to SDGs.

When businesses do business responsibly and pursue opportunities to solve societal challenges, they can deliver solutions for issues ranging from the climate crisis to poverty, inequality, and starvation. Such innovation from the private sector is a growing market, and the benefits for consumers and the planet are immeasurable when a company chooses to behave responsibly and promote positive environmental and social practices.

A 2019 survey of over 1,000 CEOs from around the world by the UN Global Compact found that 87% “believe the SDGs provide an opportunity to rethink approaches to sustainable value creation.” 70% of those CEOs “see the SDGs providing a clear framework to structure sustainability efforts.”

ESG can be both an investment philosophy and a series of core values. Companies that are sustainable tend to be builders of both profit and society, as ESG is an investment in responsible growth.

From an investor’s standpoint, the most obvious downside to ESG would be that it seems to pose limitations on which companies could be invested in, thus also limiting an investor’s potential profit. Not long ago, non-ESG investors had a wider selection of investment opportunities, and often saw much greater returns investing in businesses that could operate unhampered by environmental, social, or governance self-scrutiny.

But the tide is beginning to turn, and the pros for adherence to ESG criteria are becoming more apparent. Outside of the practical and ethical concerns, ESG criteria may help companies avoid risk factors or reputational damages that arise because of practices that fall outside of practical ESG criteria. For example, organizations that adhere to ESG social standards are less likely to become embroiled in scandals associated with unethical hiring or management processes. Companies that shift their focus toward ESG-minded practices can gain more traction, as investment firms are beginning to see ESG as an indication of low-risk.

In the years to come, there are clear indications that companies will begin to face increased scrutiny from governments, customers, and investors; those that do not promote ESG standards will likely face penalties—not only in terms of government-regulation, but also in regards to rejection from consumers and investors. In other words, as public and governmental values shift to place greater emphasis on sustainability and social accountability in business, ESG is becoming increasingly relevant across all industries.

It’s worth noting that there are two different categories of risk to consider when discussing ESG: the direct risk (climate change and other environmental considerations) and indirect risk (brand reputation, investor loyalty, etc.). With that in mind, the primary investing risks for each ESG factor are as follows:

Climate change and other environmental issues are growing. And if these issues are not addressed on a global scale soon, we may witness serious ramifications for governments, economies, and even individually operated businesses. Organizations that make the effort to be environmentally responsible may be better able to weather these challenges, offering investors increased stability.

It’s no secret that happy, satisfied, engaged employees contribute to increased business success. The reverse is also true: Unhappy employees are much more likely to underperform, hurting the business’ bottom line. But employee satisfaction goes beyond the cubicle. Businesses that follow high standards in how they treat and support their employees will have an easier time keeping top talent, and those employees will be more likely to become brand ambassadors, even when they aren’t on the clock. Taken altogether, this makes these companies a lower risk investment.

Governance details the inner working of the business itself. High standards of governance help ensure that the business in question is not involved in any illegal practices—an obvious red flag for investors. But more than that, governance promotes accurate and transparent financial processes. It assigned rights to stockholders. It helps eliminate the risks associated with conflicts of interest. Essentially, it exists to ensure ethical practices at all levels, protecting the business and those who invest in it from penalties and risks associated with poor management.

An important thing to remember is that ESG isn't a separate, independent, niche problem; it has fundamental effects on your approach to doing business (i.e., building products to be recycled, designing processes so they can be monitored for compliance with internal and external goals, etc.). Together, these are helping create frameworks for effectively approaching these issues using a system composed of people, processes, and tech working together to help companies effectively incorporate ESG as an essential component of their overall strategy, risk, and governance programs. And this means reduced risk for investors.