What is ESG finance and what does it mean for sustainability?

Everyone is talking about ESG. People are now becoming more aware of how businesses are contributing to society and the wider environment. This is seen in all industries, with a focus now being placed firmly on finance. Why? Because money talks.

Between an increasingly vigilant customer base, stricter regulations, and global competition, it’s no longer enough to have a good product or service – companies must play their part in bettering the wider society too if they are to truly win over customers for the long term. And it’s not just customers that are taking notice.

It's investors in particular that are interested in evaluating how companies are tackling ESG issues. They make use of this framework to ultimately decide where to put their money.

But let's not get too ahead of ourselves. First, let's look at what ESG means... and what it stands for.

 

What is ESG?

ESG stands for Environmental, Social and Governance. More specifically, it's a framework that identifies how a business approaches these topics as part its corporate strategy.

Think of it as a collective term that covers many different aspects that you would expect to see as part of a company’s corporate social responsibility agenda.

But here is the important part: It's used by investors and other outside parties to rank companies.

A third party (usually in the investment industry) evaluates how a business approaches topics within the realm of ESG and gives it a rating or score based on the potential risks. With this standardized system, investors and the like can rank and compare the businesses in order to make better – and more sustainable – investment decisions.

We’ve spoken before about the importance of data – and how else can investors get an unbiased insight into the topic?

ESG in a nutshell [Infographic]

In a rush? Here's a quick overview of ESG:

meaning-of-esg-infographic

How ESG works

So, the gist of ESG is that it's a means to evaluate a company based on risk in certain key issues.

But how does this work?

For the purposes of evaluation, the rating company scores the business based on pre-determined categories or key issues that fit under the umbrella of ESG.

Here are a few examples of ESG issues that may be used when evaluating a company:

Environmental

When looking at 'environment', we're of course referring to anything that has some sort of impact on it. Sustainability is already a big topic in business circles, and so we're now in a stage where companies are adopting climate-neutral strategies and other initiatives (like carbon offsetting) to reduce the impact of climate change.

Here are some examples for environmental topics within ESG:

  • Pollution

  • Climate change

  • Carbon neutrality

  • Waste management

Social

The 'S' in ESG refers to the way companies are approaching topics relating to the wider society. Think of inequality, diversity and other societal issues that affect the community. Businesses can help improve these through internal changes or otherwise setting up or contributing to outside causes that tackle these issues.

Here are some examples for social topics within ESG:

  • Inequality

  • Diversity

  • Human rights

  • Consumer protection

Governance

Governance in relation to ESG generally looks at internal structures and other related aspects such as transparency and ethics. The idea is that practices within a business can affect public opinion of the business.

A more contemporary example would be something like the disparity between the pay of the CEO and the lower-level workers, or transparency into a company's supply chain.

Here are some examples for governance topics within ESG:

  • Values

  • Transparency

  • Ethics

  • Tax strategy

What does ESG finance mean?

There is no real agreed upon definition for ESG finance specifically. But what can be understood as the meaning of ESG finance is the role of money within the ESG topic.

Basically, it looks specifically at the financing aspect - often from the perspective of investors but also the money businesses themselves are investing in the name of ESG.

Within investment and banking circles, ESG finance was (and still is) a strategy to affect the wider social environment – so-called ‘impact investing’.

Nowadays, it can even be seen as a more future-proof investment as regulations and focus shifts more onto ESG. Basically, it has a much broader appeal today compared to its more niche roots.

Speaking of broadness, ESG finance and sustainability often go hand in hand. So, what is the difference between ESG finance and sustainable finance?

Relationship with sustainable finance

While ESG finance has substantial overlaps with sustainable finance, they're not exactly synonymous.

Sustainable finance is more of an umbrella term, covering all aspects of sustainability relating to finance. ESG finance is more nuanced. As mentioned, it focuses more on the risk and investment angle and goes beyond just environmental considerations.

This can best be shown with the numbers: The global sustainable finance market is estimated to be worth more than $35 trillion [1].

Sustainable investments in the US alone account for $17 trillion, proving that there is some real financial heft behind sustainability [2].

Social and governance aspects aside (though they are just as important), ESG finance focuses more on the environmental considerations relating to investments for and funding of programs, projects, initiatives and businesses that benefit the wider society. Examples can include.

Essentially, ESG finance is more like a subset within sustainable finance. It does look at carbon-offsetting and other internal policies aiming to reduce electricity and paper usage, but it also looks at societal and governance topics.

But that's not to downplay its importance in sustainability – it plays a significant role in informing others and enabling investment into more sustainable businesses.

So there's our answer. But we have a plenty more to cover on the topic of ESG and how it is implemented.

ESG data and ratings

It’s all well and good for businesses to claim they are taking steps to be ‘greener’ and acting as such, but demonstrating this is a whole other story.

Is bleisure travel a sustainable option? How much of an impact does it actually have? That’s where specialized software and resources are needed to not only track but analyze data. Even then, it is usually a ballpark figure or a more general estimate. But that doesn’t mean it is useless – far from it.

Thankfully, ESG data has become increasingly accessible over recent years, though there is still a way to go. After all, it’s one thing to have the data available, but clear and thorough reporting of this data is vital when it comes to ESG topics.

The rating and reporting of ESG scores is the foundation of understanding how businesses are approaching sustainability. It's no surprise then that a whole market has appeared around this.

These third parties – sustainability analysts and rating agencies – regularly evaluate the activities of businesses according to ESG (Environmental, Social, and Governance) criteria.

Let's look at one of the biggest names in the space, MSCI, as an example.

MSCI ESG rating system

MSCI, one of the world's leading index providers, has developed its own ESG rating system to create its sustainability indices. It uses a seven-tier rating system to ultimately score a business, from the lowest 'laggards' (CCC) to the highest 'leaders' (AAA) in the space.

msci-esg-score-rating

Interestingly, in the case of MSCI, a system of weightings and number scores are used. Each individual issue is given a numerical score that is added up and then, based on the weighting for each issue, rounded to a final score. This final numerical score is then translated into the rating seen above.

This system offers a quick an easy way to determine the performance of a business in terms of ESG, while also coming from a reliable source. It helps too that the process is transparent.

The issue of standardization

It's all well and good to have these ESG scores available, but the system could be better.

Up to this point, there has not been any real universal standard of what constitutes sustainable finance [3]. In fact, there is no single definition of ESG finance out there.

What counts as an ESG investment? What one person sees as ‘social betterment’ may not be seen that way by others. How can you directly compare one business’ approach to sustainability to another when they go about it in different ways?

This is why a standardized system is needed. This will enable not only qualitative measurements, but quantitative comparisons, ultimately making compliance easier. This also makes life easier for investors looking to choose socially responsible businesses to support.

There also needs to be a fine balance in order to aid the adoption of ESG reporting. It needs to be detailed enough to provide the necessary information for an informed decision but should not be so difficult to produce that it deters full cooperation or acts as a barrier for smaller businesses.

This is more of an infrastructure issue. Thankfully, new guidelines are beginning to appear that should provide more structure and proper guidelines for how ESG should be reported [4].

The impact of regulations on ESG

As mentioned, regulations on sustainable finance have helped bring ESG to the forefront. The EU, for example, is pushing hard on this, as evidenced by the European Green Deal.

This deal is enacting new policies that are meant to lead towards a “transition to a low-carbon, more resource-efficient and sustainable economy and has been at the forefront of efforts to build a financial system that supports sustainable growth.” [5]

Such initiatives are likely to start appearing more often as governments start taking action and becoming more aggressive to reach their lofty climate targets. What this is likely to translate to for corporations is incentivization to get onboard with sustainability, which is why ESG is so important.

Incentivization doesn’t have to come from governments though. Shareholders are also playing a role by linking environmental targets to additional bonus payments [6].

This is not to mention pressure from outside movements by the wider community, which all just goes to show how hot of a topic ESG finance is right now.

With this in mind, businesses have started to implement the necessary measures, whether that be removing plastic straws or changing their approach to business travel. But these changes need to be sustained and meaningful, which is not always the case.

What ESG means for businesses

For some businesses, sustainability is more of an after thought.

The problem is that some of the more direct investments in environmental, social and governance initiatives don’t exactly offer immediate returns. They are an investment of both time and money.

Therefore, businesses need to be looking more long term and even outside of their industry. After all, there is a growing pool of evidence that ESG investments do indeed pay off.

Around 70% of studies on the relationship of ESG on financial performance found a positive relationship between the two [7].

And it’s making a difference.

Corporations have the greatest potential impact on key environmental factors, whether through direct practices or investments that help offset carbon output or innovate in the area. And let's not forget the 'S' and 'G' of ESG.

The role of social and governance

We’ve mainly been looking into the environmental aspect of ESG finance, but that is not to say that the social and governance elements are not important. There is a reason the three are joined together: they represent a broader shift in the corporate landscape.

One where inequality, inclusiveness, management structures, renumeration and carbon footprints are being placed under the microscope as businesses are expected to play a part in the betterment of society. It’s not just an image thing – they have a responsibility to do so.

Governments, shareholders and the wider public are just as interested in the impact of businesses on society and governance structures as they are the environment. Again, ESG finance can be seen as an extension of corporate social responsibility, and so it should be approached in the same way.

Many are starting to make strategic changes for how they use their finances for the better and the impacts they have. This can be seen as one of the key end goals for ESG.

How we can help

On top of optimizing your corporate payments, we at AirPlus are continuing to find ways to approach ESG and sustainability – and enable you to further improve your approach.

We have been able to make centralized travel payments more environmentally friendly. Our entire product line up is now climate-friendly through the financing of a climate protection project – made possible by the international non-profit organization myclimate.

To ensure the safety and well-being of travelers, we also now offer access to a virtual initial medical assessment. The Telemedicine Assistance service enables those on the road to gain access to an initial medical assessment online with a general practitioner via the 'Doctor Please!' app.

Additionally, we look to further contribute to ESG topics by providing employees with job tickets to promote the use of public transport, making donations to local organizations that do good in our community, and more. You can learn more on our dedicated CSR page.

This is all to say that ESG is not just about what your company does internally, but also who you work and collaborate with.

The end goal of ESG

Now we know what ESG stands for, its role in sustainable finance and how ESG data and reporting come into the picture.

So, what exactly is the end goal of this push for ESG finance? To put it simply, it’s to bring about a truly sustainable financial industry – one that provides satisfactory conditions for workers and the society they operate in.

Sure, it can be approached as a public relations project, but putting real thought and action into your approach to ESG will likely have several positive repercussions in the long term. Truly sustainable finance is arguably the only kind that will allow value to be continually created.

It appears to have a positive effect on company finances too, despite a prevailing belief of the opposite. Investors are also becoming more savvy on this topic, and as more attention continues to pour into this area, analysis will become better and more thorough. Corporates need to take notice, if they haven’t already.

Speaking of corporations, they will need to look inwards to identify ways to reduce their impact on the environment, whether that be reducing usage of paper, electricity or otherwise, as well as investing in projects that will help maintain a healthy society.

That is to say, ESG finance is important but it’s not full picture. It should be part of a wider strategy adopted by businesses to make meaningful and effective change.

To answer the question of what ESG finance means for sustainability: It means another, trackable and data-driven means of pushing forward planet and society-friendly initiatives within the corporate space. They have the potential to make a huge difference in the ESG causes.

So yes: Money talks… but actions speak louder than words – and ESG is laying down the groundwork for an effective way to track that.

Interested in learning more about how finance will play an essential role in corporate sustainability? Subscribe now for our newsletter to get the latest blog posts and more each quarter.

 

Banner photo by Visual Stories || Micheile on Unsplash

[1] The $35 Trillion Sustainable Finance Market Gets Greater Clarity | Bloomberg.com

[2] European ESG Assets Shrank by $2 Trillion After Greenwash Rules | Bloomberg.com

[3] Closing the disconnect in ESG data in financial services | KPMG.com

[4] ESG Impacts On Financial Reporting | Forbes.com

[5] Overview of sustainable finance | Europa.eu

[6] US companies add environmental and social targets to executive bonuses  | FT.com

[7]  Why ESG is here to stay | McKinsey.com


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