The value of global assets applying ESG data to drive investment decisions today is $40.5 trillion in 2020. ESG is no more a choice as a filter for sustainable businesses, it has become an integral part of investing. Historically, markets have focused on the outcome of business based on financials of an organization and high ROE, but today understanding how the company is run, the business model, management of the assets owned creating avenues for cash flow and investment performance is given importance. These are the factors that affect and point in the direction of the long-term sustainability of the business.
The 3 pillars of ESG:
Environmental Impact: This factor involves organizations that depend on the use of natural resources for manufacturing. The efficiency in which the organization carries out its services or product manufacturing process, keeping in mind the environment.
Social Impact: Human capital management and controversial sourcing, employee safety measure and measures again occupational hazards, CSR initiatives and ways the organization is giving back to the community all these play an important role calculating the social quotient of the business.
Governance Impact: The hygiene factors like good practices, policies and disclosures, zero tolerance to corruption, high ethics, audits and compliance all fall under the purview of good governance.
While social impact and governance are comparatively simple to evaluate, it is the environmental impact that is hard to gauge. There is no standard rating data points that are available across industries to rate an organization on its environmental friendliness. Availability of data is scarce to judge a company’s points from an environmental standpoint. Most rating organizations are following the procedure of individually collecting information by reaching out to these organizations for data and information. Unfortunately, the quality of data and its comparability may still be insufficient in most cases for a comprehensive comparative study.
How do you compare the environmental impact of a tech based or services based organization in comparison to a mining company? To identify the best environmental or socially compatible organization within a particular sector we need to compare the same within its peer organizations from a qualitative perspective. Here the parameters followed would be to do an apple to apple comparison and choose organizations with a better ESG score and transparency within the same domain of expertise. An ESG score is currently defined on the basis of SEBI’s mandate requesting 1000 listed companies to prepare a yearly business responsibility report (BRR) disclosing the levels of adoption of responsible business practices.
Currently, there is no standard procedure or agency who is responsible for rating businesses on the Environmental quotient, but as the markets evolve and the absolute need for ESG ratings become mandatory across businesses we may likely have a standard procedure in place for easier evaluation of businesses on ESG parameters.
Non-financial impacts on business which fail to follow ESG norms:
- Climate change
- Sustainable farming/mining
- Privacy and data security
- Greater regulatory scrutiny
- Lifestyle changes
Low ESG Score = Higher Risk
Businesses which prudently follow ESG norms are considered sustainable businesses that are unlikely to be easily deterred by non-financial impacts. The current pandemic scenario that has brought economies to a screeching halt will be a testing time for businesses which are not sustainable in every sense. Such events can have a meaningful impact on the value of a firm thus separating the healthy business from the unhealthy ones. Here is how following ESG norms and parameters can add value to investors:
- Sound sustainability standards lower the cost of capital of companies
- Solid ESG practices result in improved operational performance
- Good sustainability practices have a positive influence on the performance of shares
Strong firm governance in keeping with economic and social standards will definitely lead to superior operating performance and greater stock returns. Currently, in India, there are 4 investment opportunities that follow the ESG investing, the future for it is undeniably bright.