Anyone looking for fair, sus­tain­able al­tern­at­ives on the stock market might be quickly over­whelmed. Not every stock that looks en­vir­on­ment­ally friendly or socially conscious at first glance will make good on those promises. That’s where En­vir­on­ment­al, Social, Gov­ernance (ESG) criteria come in. The various ESG criteria address whether a company meets a number of standards regarding the en­vir­on­ment, social re­spons­ib­il­ity, and gov­ernance.

What are En­vir­on­ment­al, Social, Gov­ernance criteria?

ESG criteria are a set of standards that have become a mainstay in the area of in­vest­ment. Both in­sti­tu­tion­al and private investors place more and more value in making sus­tain­able and ethical in­vest­ments. Now companies can vol­un­tar­ily commit to upholding the various ESG criteria through the UN or­gan­isa­tion Prin­ciples of Re­spons­ible In­vest­ments. The or­gan­isa­tion has over 4,000 sig­nat­or­ies worldwide, who with their par­ti­cip­a­tion have committed to in­teg­rat­ing ESG prin­ciples into their business practices.

Overview of ESG criteria

The various En­vir­on­ment­al, Social, Gov­ernance criteria touch on the three com­pon­ents of en­vir­on­ment and sus­tain­ab­il­ity, social re­spons­ib­il­ity, and lead­er­ship/gov­ernance.

En­vir­on­ment

The first category of ESG focusses on en­vir­on­ment­al sus­tain­ab­il­ity. These criteria aim to ensure that, for example, the company is pursuing the use of renewable energy and pro­tect­ing the en­vir­on­ment. There is a wide range of en­vir­on­ment­al criteria — these are the most important ones:

Criterion Ex­plan­a­tion
Con­ser­va­tion of biod­iversity The company must ensure that it’s not en­dan­ger­ing biod­iversity. For example, de­for­est­ing rain­forests and over­fish­ing should be avoided.
Con­serving resources The company must work in a way that conserves resources, for example im­ple­ment­ing recycling programs.
Climate pro­tec­tion/low emissions The company must take action to slow climate change. For example, CO2 emissions can be reduced by short­en­ing supply chains.
Investing in renewable energy The company must get its power from green energy sources, for example using green hosting.

Social

The next area of ESG criteria is social re­spons­ib­il­ity, which em­phas­ises fair and ethical business practices as they relate to other people. Some major social criteria include the following:

Criterion Ex­plan­a­tion
Equal op­por­tun­it­ies The company needs to implement equal op­por­tun­it­ies measures, for example ensuring that all genders are paid equally and that its workforce is diverse at all levels.
Human rights Human rights must be respected. The company must avoid pur­chas­ing goods that were produced in inhumane con­di­tions.
Employee pro­tec­tion and labour rights The company must comply with ap­plic­able labor law with respect to its own employees. Moreover, the company must watch out for the health of its employees by providing safe working con­di­tions.
Freedom of assembly and the right to unionize The company must support employees’ right to unionize and the freedom of assembly.
Corporate social re­spons­ib­il­ity (CSR) The tenets of CSR should be upheld.
Sus­tain­ab­il­ity standards with suppliers and sub­con­tract­ors The company should ensure that ESG standards are im­ple­men­ted by suppliers and sub­con­tract­ors.
High standards for health and safety The health and safety of employees must be of high priority.

Gov­ernance

The last aspect of ESG criteria is gov­ernance and lead­er­ship. These criteria are meant to ensure that certain values are upheld in the way that the company is run. These are the most im­port­ance gov­ernance criteria:

Criterion Ex­plan­a­tion
General business ethics The company needs to commit to moral prin­ciples and act ethically.
Pre­ven­tion of cor­rup­tion and bribery Cor­rup­tion and bribery should be prevented at every level of the company.
Wages and com­pens­a­tion All employees should be paid a fair wage. The company might consider using part of the board’s com­pens­a­tion to implement further en­vir­on­ment­al measures.
Corporate gov­ernance In ac­cord­ance with corporate gov­ernance, the company should ensure trans­par­ency, risk man­age­ment, and equality.

How do the ESG criteria work?

Acting sus­tain­ably is not always an end in itself. For many companies, investing in sus­tain­ab­il­ity pays off in the long term. This is in part because sus­tain­ab­il­ity has taken on a bigger and bigger role in wider society in recent years.

However, as­sess­ments of sus­tain­ab­il­ity using ESG criteria don’t work the same for all companies. The sector that a company is operating in plays a big role, es­pe­cially when it comes to the en­vir­on­ment­al arm of ESG. CO2 emissions will play a much bigger role in the eval­u­ation of an energy company than a business in the service sector. For the service sector, the social criteria will be far more important.

It’s only with regard to the gov­ernance criteria that almost all companies are held to the same standard. When it comes to corporate gov­ernance, con­sid­er­a­tions like having an in­de­pend­ent board and es­tab­lish­ing fair business ethics should be promoted across all sectors.

ESG ratings

Ratings determine how safe an in­vest­ment is. Generally, the dis­tinc­tion is made between bank internal and bank external ratings. The latter are carried out by a spe­cial­ised company, called a rating agency. A large number of agencies spe­cial­ised in ESG ratings have sprung up on the market. These ratings are a way for investors to determine whether their own standards for sus­tain­ab­il­ity, social re­spons­ib­il­ity, and gov­ernance are fulfilled by a company. The American agency ISS ESG and the Dutch company Sus­tainalyt­ics are two of the most well-known ESG rating agencies. Classic rating agencies like S&P also offer ratings with regard to the ESG criteria.

Com­pli­ance with ESG criteria

Com­pli­ance with ESG criteria is checked by rating agencies on behalf of investors. The agencies use different point systems to deliver ESG scores for companies. Due to the dif­fer­ences between their scoring systems, it’s hard to compare ESG ratings from different agencies. However, what each rating system has in common is that it is based on the ESG criteria. Concrete factors such as CO2 emissions and wages are scored based on reports from the company. What’s harder to evaluate are in­tan­gible factors such as employee sat­is­fac­tion.

Reviewer

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