What Is ESG and Why Does It Matter?

esg

In recent years, more businesses and investors have shown increased interest in following ESG criteria. Now, many are opting to prove transparency and ethics through financial interests. 

As a result, companies are now developing products that exclusively follow ESG criteria. With increasing interest in ESG criteria and newer generations of investors, many financial advisors have an ESG platform to cater to these criteria. 

But what does ESG stand for, and how does it help shape more ethical companies?

What is ESG

ESG stands for environmental, social, and governance. Many investors use these three criteria to help identify risks and opportunities for growth for their company. ESG criteria help encourage responsible business practices.

Not every business strictly adheres to ESG criteria while performing financial reports. Recently, companies have begun implementing pieces of ESG in other annual or sustainability reports

When a business states they follow ESG criteria, what does this mean? ESG-practicing companies declare they conduct ethical business practices in the three areas ESG covers. Companies use various strategies and solutions to comply with ESG standards.

Types of ESG criteria

There are three different ESG criteria: environmental, social, and governance. Responsibility in these three areas ensures steps toward holding companies accountable and ensuring best business practices.

Environmental

Environmental criteria focus on preserving the earth. Some standards businesses may follow in this category include energy use, waste levels, and treatment of animals. Adherence to these criteria also helps companies assess and evaluate possible environmental risks.

More examples of environmental ESG are:

  • Climate change
  • Air pollution
  • Deforestation
  • Carbon emission reduction

Social

Social criteria consider people and their relationships with one another. For many businesses, this means evaluating the company’s relationship with stakeholders.

Companies must hold their suppliers to higher standards and consider budgeting a percentage of profits to give back to the local community. These criteria also encourage safe, healthy, and productive workplace conditions.

More examples of social ESG include:

  • Gender inclusion
  • Diversity
  • Mental health
  • Community relations

Governance

Governance criteria focus on the logistics of operating a business. Adhering to these criteria means companies are transparent about finances and select ethical individuals for leadership positions.

More examples of governance ESG include:

  • Hiring and onboarding practices
  • Political contributions
  • Board of directors
  • Executive compensation

ESG criteria pros and cons

The idea of ESG criteria is appealing, but it is not for everyone.

Even if you invest in a well-performing ESG fund or two, omitting certain companies or categories from your portfolio can impact your result.

For example, the tobacco industry is known to produce large financial returns. However, those following ESG criteria could never invest in the tobacco industry making them lose out on crucial investments.

Many companies also have a different definition of social responsibility, and with an effective marketing campaign, anything is believable. 

Before you go

Ultimately, the true value of ESG criteria shines when businesses commit to using the guidelines to strive for actual change through their investment choices.

As newer generations of investors continue to put pressure on companies to do more than just check boxes under the ESG criteria, more companies will shape up into ethical ones in the near future.

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