SW News 17
ESG versus Sustainability
ESG versus Sustainability
Unless you’ve been living under a rock for the last year you’ll have noticed the buzzword of the moment: ESG. It stands for environmental, social and governance. And it’s everywhere! The term ESG is often used interchangeably with sustainability. But are they the same thing?
In our view, ESG and sustainability are two sides of the same coin, inextricably interlinked, but originating from different places and with different end goals.
Sustainability, as practiced in companies, is about managing the impacts a business has on people and the planet. It’s also about managing the impact of environmental and social megatrends on the business. A strong sustainability strategy should seek to transform a company’s business model so that the business ultimately operates in a way that is fair and equitable to people, and within planetary boundaries.
Over the last 20 years, companies have been sharing information on their economic, social and environmental impacts via sustainability reports. While this ‘non-financial’ information has always been scrutinised by NGOs such as Greenpeace or Human Rights Watch, it was historically of little interest to investors. This began to change in 2005, which is when the term ESG first started to appear, evolving from another three-letter acronym – SRI, or socially responsible investing. (Check out this excellent article for more details).
ESG only really went mainstream a couple of years ago however. Now, ESG investing is a huge trend. It’s about the integration of environmental, social and governance factors into investment processes and decision-making. It has risen up the agenda because investors recognise that ESG factors, such as how a company is responding to climate change, how it is managing human rights in its supply chain, or how it treats its workers, can have a financially material effect on a company’s valuation. The previously irrelevant ‘non-financial’ information is now relevant because it’s been shown to affect the bottom line.
So where do ESG and sustainability meet? First off, it’s worth saying that ESG is on the agenda not just of investors but of all financial stakeholders - banks, insurers, financial regulators, financial policymakers and the analysts and ratings agencies that serve them. The topics that these financial stakeholders want to know about will be many of the same topics that a company is addressing in its sustainability strategy and reporting on in its sustainability report. However, typically there is a subset of topics that finance players are most interested in – the ones that they think could materially impact the financial performance of a company. Or, if you’re the Central Bank for example, the ones that could destabilise the financial system (e.g. climate change). Governments also need to steer private capital to fill the decarbonisation investment gap, so they are interested in the “greenness” of the economic activity of businesses.
From a company’s point of view, ESG is about providing relevant data and information on these financially material environmental, social and governance topics and showing that the business is managing them well from a risk/opportunity perspective.
In summary, ESG is the domain of the financial sector – investors, fund managers, banks and others. Its goal is risk management and stronger financial returns. If implemented well, ESG will channel money away from unsustainable businesses and industries and into sustainable ones. But the ESG agenda is, in our view, a sub-set of sustainability. Sustainability (in business) is the domain of CEOs and their employees. It’s goal is business transformation – fundamentally re-designing how a business works so that it has a place in a low carbon, circular, more equitable world. If implemented well, sustainability - as driver of transformation - will create companies that genuinely use business as a force for good, changing lives and improving society for the better, while also making money.