Environmental Social and Governance (ESG) Criteria: Every investor has his own criteria for making potential investments. While some investors look for quantitative factors including revenues, profits, dividends, cash flows, etc., there are investors paying attention to non-financial factors.

Investors nowadays are increasingly applying non-financial factors as part of their analysis process. They screen investments on these factors and identify material risks and growth opportunities. 

This has given rise to ESG Investing. ESG is an acronym for Environmental, Social, and (Corporate) Governance. These are the 3 categories, or areas, of interest for “socially responsible investors.

Environmental, Social, and Governance (ESG) Criteria image

These investors consider that it is important to incorporate values and concerns (like environmental concerns) into the selection of investments rather than simply considering the financial variables.

Simply put, ESG criteria dictate environmental, social, and corporate governance factors which are considered when investing in a particular company. Though its origin dates back to several decades, this concept has gained importance for socially responsible investors in recent years. 

Since investors are now paying attention to ESG investing, brokerage firms and mutual fund companies are now offering ETFs and other financial products following ESG criteria. This criterion is also increasingly affecting the investment choices of large institutional investors including public pension funds. 

This article talks about the Environmental Social and Governance (ESG) Criteria. Keep reading to find out more!

Environmental Social and Governance (ESG) Criteria

Let’s look at the meaning of these letters –

1. ‘Environmental’ Criteria in ESG

“E” refers to the environment and it encompasses the effect that activities of the companies have on the environment – directly or indirectly. The environmental aspect relates to the company’s impact on the environment and its capability to manage and mitigate risks harmful to the environment.

A certain company’s carbon footprint and its record of energy efficiency, waste management, and conservation of water, and other natural resources all form part of the environmental aspect.

Other environmental aspects include sourcing of raw materials and whether or not a particular company follows biodiversity practices on the land.

2. ‘Social’ Criteria in ESG

“S” stands for social and it encompasses the impact a particular company has on the social environment in the community. The social aspect assesses the company’s relationships with other businesses and its position in the local community.

Other aspects include the company’s commitment to diversity and inclusion among the workforce and directors. Basically, this criterion covers a vast range of potential issues.

Examples include: What is the structure of the employees’ pay? How are employees paid in comparison to comparable jobs or similar positions? What sort of retirement plans is being offered to the employees? What is the mission statement of the company? Is the mission statement socially relevant and beneficial to the society around it?

3. ‘Governance’ Criteria in ESG

“G” for governance hints at the company’s corporate governance and the practices related to it. For example, the composition and diversity of the company’s Board of Directors, transparent policies, its codes of conduct, executive compensation, whistle-blower schemes, etc.

Are part of corporate governance. Basically, governance means how a particular company is being managed by top executives or the leadership team. How does the company’s board of directors attend to the interests of various stakeholders? Stakeholders include the company’s employees, suppliers, shareholders, debt holders, and customers.

A company is said to be following a policy of good corporate governance if it follows financial and accounting transparency and it has full and honest financial reporting standards. Other elements include:

Are board members of the company acting in a genuine fiduciary relationship with stockholders? Is the Board a diverse and inclusive group? Some ESG investors tend to focus on the compensation of the Board members.

These investors don’t favor multi-million-dollar bonuses to its executives while the same company imposes salary freezes or salary reductions for all the other employees. Basically, these investors think about whether or not extra compensation for executives is tied to increasing long-term value and profitability.

Several companies track their own performances keeping in mind ESG metrics and explain those performances in their respective annual reports and other company-related or financial documents.

ESG criteria for a range of individual companies are also measured and published by third-party providers. Investors need to research the companies to find out their scores in terms of ESG criteria to make informed investing decisions.

ESG reports of the companies are available on the web and investors can search online. Since companies report and rate themselves on ESG criteria, it is always advisable to seek validation from third parties.  

In Closing

In today’s conscious investing, a range of investors constantly looks for companies built on sustainability as these companies are likely to deliver strong returns over the long -term and they can tide over challenging times.

Investors try to understand different aspects which can contribute to the stability and continuity of the companies they choose to invest in. Investors tend to choose those companies which are able to survive the severe impacts of any crisis and the companies that can incorporate ESG factors in their day-to-day functioning. 

The companies having good practices are expected to eventually generate healthy profits through brand building and continued customer patronage. In the long run, these companies can experience increased brand loyalty.

That’s all for the article on Environmental Social and Governance (ESG) Criteria, Hope you enjoyed reading it. Happy Investing!

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