What is ESG About?
“ESG” stands for “Environmental, Social and Governance”. The ESG acronym is being increasingly used as a shorthand term for a wide range of issues relevant to how a business can have a net positive impact on the world and how it can demonstrate that it is having that impact.
All ESG issues relate in some way to the running and resilience of a business and what that business must do to be a “good corporate citizen”. ESG issues are usually listed under three broad headings: “Environmental”, “Social”, and “Governance”, but there is a degree of overlap between issues that fall under each of those headings.
Origin of ESG
There is a growing body of standards and requirements that regulate this area, some legally binding, others not. ESG did not come from any single source, but rather it was a development sparked by institutional investors demanding that if they are to invest in a business, it must meet certain standards in a variety of areas, depending on the type of business in question.
Being a Good Corporate Citizen
ESG establishes what a business needs to do to be a “good corporate citizen”.
A business firstly needs to comply with all measures having the force of law that are applicable to it, including statute and common law, regulatory rules, and other legal obligations or duties (see “Legal Compliance”, below). Increasingly though, legal compliance alone is regarded as insufficient, and the ESG concept embraces a good deal more.
ESG secondly recognizes that, in the interests of stakeholders (such as suppliers, customers, tenants, employees, shareholders, investors, suppliers of finance, neighbours, and the community at large), businesses should, in relation to their activities and conduct, also meet other relevant domestic (and often international) codes, standards, and behaviours, including appropriate standards of business ethics and morality, as well as others’ reasonable requirements and expectations. More widely, it also embraces “sustainability”, i.e., a business’s efforts to reduce its negative impacts and increase its positive impacts on the world around it.
The “good corporate citizen” and sustainability aims are important aspects of ESG, but ESG is ultimately about resilience of businesses. The Covid-19 pandemic has led to an increased focus on business resilience. If a business complies with ESG “good corporate citizen” and sustainability principles, laws, and behaviours, it not only benefits stakeholders and the environment, but it also renders it more resilient, i.e., more likely to survive and succeed. In contrast, failure to comply can ultimately damage the business, its goodwill and reputation, or it can prevent it from meeting its maximum potential (see “Why should you take ESG on board?”, below).
As to ESG-related standards, codes, behaviours and other requirements which do not have the force of law, these are so numerous and wide-ranging that it would not be practicable to set out here even a small portion of them as examples. Whether any particular requirements of that nature are relevant to a business will depend on many factors including the size and type of business.
As to ESG-related obligations and regulation of businesses which do have the force of law, although they are only a part of the totality of ESG requirements, standards, codes, and behaviours, they are set to keep increasing. Such legal measures are already considerable and wide-ranging, and the following offers no more than a flavour of just a few of them that might be relevant to businesses. Such legal measures include:
- Companies Acts requirements for certain companies to issue statements and reports on dealing with various ESG issues (including climate-related, environmental, and other non-financial matters such as social and employee-related matters disclosures, as well as financial matters);
- Bribery Act;
- Modern Slavery Act;
- Equality Act;
- Health & Safety at Work Act;
- Common law obligations and duties, e.g., the law relating to negligence, nuisance;
- Consumer Protection Act (product liability);
- Environment Act, Environmental Permitting (England and Wales) Regulations, Environmental Damage (Prevention and Remediation) Regulations, Water Resources Act, and various other environment law statutes.
What is the Subject Matter of ESG?
ESG brings together disparate elements, a number of which are outlined below. The following lists include some key ESG areas, but are by no means a comprehensive listing of ESG elements. However, this does illustrate the breadth of topics falling under the ESG umbrella. Whilst a variety of separate issues fall under that umbrella, those issues are increasingly linked to each other.
It should be emphasized though that not all of the following elements of ESG will be applicable to all businesses. Whether any particular ESG element, issue, or risk is relevant to a particular business will depend on various factors including the type of business, its size, whether it is a company or is in unincorporated form, whether it has shares that are publicly traded, whether it is engaged in an activity that is highly regulated, whether it operates outside the UK, or whether it has dealings with anyone outside the UK.
Environmental Elements of ESG
This aspect of ESG focuses on improving the environmental performance of a business. It measures a business’s impact on the natural environment and the natural environment’s impact on the business, for instance, through physical climate risks. It takes into account factors including a business’s carbon footprint, its impact on biodiversity, and its production of waste and pollution. It includes the following topics:
- climate change;
- greenhouse gas emissions (in particular carbon dioxide);
- emissions to air, water, and land;
- product carbon footprint;
- pollution and waste (toxic emissions and waste, packaging material and waste, electronic waste);
- deforestation and land use;
- treatment of animals;
- energy efficiency;
- raw material sourcing;
- resource depletion (including water);
- environmental opportunities (clean tech, green building, renewable energy).
Social Elements of ESG
This aspect of ESG focuses on a business’s impact on people. It measures how a business treats people such as employees, customers, and the communities in which it operates. It includes the following topics:
- human resources and hiring;
- human rights (including modern slavery and child labour);
- supply chain labour standards;
- health and safety;
- product safety, quality, and liability;
- chemical safety;
- financial product safety;
- wide ranging diversity and inclusion requirements, including anti-discrimination and anti-harassment (D&I);
- equal pay;
- privacy and data security;
- conflict zones and conflict minerals;
- controversial sourcing;
- stakeholder/community relations and engagement;
- customer satisfaction;
- company cultures;
- employee advancement opportunities;
- employee education and welfare;
- philanthropy (e.g., donations to local community, employee volunteering programmes).
Governance Elements of ESG
This aspect of ESG focuses on a business’s leadership and structure. It measures how a business operates in terms of audits, board diversity, internal controls, and shareholder rights. It includes the following topics:
- bribery and corruption;
- executive pay;
- board independence;
- business ethics;
- board composition and audit committee diversity and structure;
- financial system instability;
- tax transparency;
- political contributions;
- conflicts of interest;
- anti-money laundering;
- anti-competitive practice.
Why Should You Take ESG on Board?
ESG is inevitably relevant to larger businesses, but it is also increasingly becoming more material to start ups and smaller organizations. Businesses should be seriously considering ESG in view of the potential positive impact on it of taking ESG on board on the one hand and the potential negative impact of not doing so on the other.
What, then, might such positive and negative impacts be?
Positive impacts of adopting ESG
- meeting shareholder activists’ expectations or requirements so that they are kept “on-side” and supportive of the business;
- encouraging potential investors to invest in the business. Many major banks and investors include ESG investing criteria in their processes and products;
- improving relations with regulators/government;
- enabling the business to contract with those suppliers and customers who require their business partners to adhere to ESG standards;
- attracting and retaining employee or volunteer talent;
- better productivity;
- positively influencing customer sentiment;
- achieving costs savings (e.g., reduced waste or energy consumption).
Negative impacts of not adopting ESG
- harming or failing to improve reputation or morale of staff;
- failing to realize full potential sales turnover;
- dissuading potential investors from taking, retaining, or increasing a stake in that business;
- loss of opportunities to tender for contracts due to failure to meet ESG standards required by tender conditions;
- failing to attract investment or to meet qualifying conditions for grants or other financing;
- incurring additional costs, expenses, fines, or other penalties;
- incurring additional legal liabilities.
Adopting an ESG Policy and ESG Strategy
Adopting, publishing, and implementing an appropriate ESG policy can assist a business to identify and state clearly those factors that pose a risk to the business, i.e., factors that can directly or indirectly harm the business in any way. Such risks include the risk of litigation or liability; regulatory enforcement; risk of physical damage, loss, personal injury, or harm to health; commercial risk; and reputational risk. Identifying risks is the first step to minimizing them and planning for the eventuality that they materialize.
If a business additionally includes in its ESG policy a commitment to measure its degree of compliance with the policy (and report to its board or publicly on its compliance), it will not only have a basis for informing stakeholders and others about the extent of that compliance, but it will also highlight for itself and others how it is mitigating risks. In short, adoption, publication, and implementation of an ESG policy can aid business resilience.
Once a business has formulated an ESG policy, it needs to work out and document a strategy for implementing it. This will entail creating processes for doing so, including the means for measuring and reporting periodically on progress in implementing its ESG policy. In that connection, it should specify – using clear metrics – what will be achieved and when it will be achieved.
Prudence dictates that a business firstly ensures that the ESG policy that it formulates is consistent with its culture and values. Secondly, it must be realistic: a business may be tempted to cover a very wide range of matters, but should only say what it can realistically do, only set targets and timescales that it reasonably expects to achieve, and be prepared to report on why it has not achieved them. Otherwise, it will have failed to comply with its own ESG policy, producing a damaging effect to its reputation and its success.
For many businesses and other organizations, being able to meet some of the aims set out in their ESG policy depends to a significant extent on taking steps to ensure that companies in their supply chain comply with aspects of their customer’s ESG policy.
A business might carry out due diligence checks or take other steps to assess prospective suppliers’ management of ESG issues. Some businesses have a supplier code of conduct (covering a range of ESG criteria) to which they require suppliers to sign up. Many businesses include a standard “compliance with ESG and other policies” clause in their contracts with suppliers that obliges suppliers to comply with ESG-related policies which the business lists in a schedule attached to the contract. This might be combined with a “self-certification” clause whereby the supplier certifies periodically that it and its subcontractors are meeting the compliance requirements. Some businesses include an audit clause in their supply agreements giving them a right to audit aspects of the supplier’s provision of the goods or services under the contract. In each case, the contract can specify the consequences (e.g., termination, remediation) of the supplier’s non-compliance with ESG clauses in the contract.
It can be seen from the above that ESG is not, and should not be treated as, just a “box-ticking” or “flavour-of-the month” topic. In the interests of the long-term survival and success of any business, it should be seriously considering how ESG is relevant to it.
Simply-Docs ESG Materials
There are currently a number of template environmental policies and environmental policy statements available to download. Whilst these specifically cover environmental matters and can assist with implementation of some environmental aspects of ESG, those templates are not designed to cover other ESG issues as well. However, from time to time, templates and checklists will be added to the website to deal with Social and Governance issues as well as Environmental issues. The first of these, a template set of Company Directors’ Board Minutes adopting an ESG strategy, is available here.