ESG in a Nutshell
The goal of Environmental, Social and Governance (ESG) programs is simple: minimize risk, increase shareholder value and contribute to solving societal problems; but do so in a way that is at the same time good for your business, society and the world around us. ESG investing, sometimes called sustainable investing, refers to the application of non-financial factors to investor decision-making processes when identifying material risks and growth opportunities. At a high level, this approach seeks to deliver a “triple bottom line” (balancing profit, people and the planet) – or simply, “do good and do well” by adopting business practices that attend to important extrinsic priorities that align (and, hopefully, drive) sustainable bottom line growth.
While the term ESG has gained popularity as a lens through which attractive investments can be evaluated, it has made its way into corporate boardrooms and has become a tool for both shareholder activism and providing a voice for employee priorities. Today, ESG extends well beyond the investing industry and is embraced by stakeholders, customers, suppliers and employees as an indicator of strategic organizational sustainability. Key considerations include:
Environmental factors refer to an organization’s environmental impact, including greenhouse gas emissions, climate change, flooding, resource efficiency, natural resource utilization, organizational resiliency against climate risks and contributions to environmental sustainability.
Social factors refer to an organization’s relationship with stakeholders and how those relationships impact the communities in which they operate. This includes considering wages, employee engagement and human capital management. The effects extend beyond the organization per se, extending to supply chain partners and partners to build required fundamental compliance with fairness and equity standards – whether locally or internationally, by requiring robust labor standards, racial and income equality and observances that honor fundamental social and human rights.
Corporate governance refers to the organization and leadership of the company. One considering ESG factors should look to leadership to determine how their motivations align with stakeholder priorities, recognition of stakeholder rights, as well as leadership transparency and accountability, balanced against the exigencies of operating a profitable, sustainable business.
Current Attitudes and the Future of ESG
ESG considerations have evolved considerably since their origins in the 1960s, circulating under a range of similar names, such as Corporate Sustainability or Corporate Social Responsibility. But ESG has evolved from a reactive consideration to a proactive movement. Institutional investors and banks have begun publishing comprehensive analytics and providing scores for companies based on how they fare with ESG factors, creating a mainstream focus on the practice. In recent years, this lens for evaluation has emphasized the pragmatics of attending to the world at large while generating long-term sustainable shareholder returns. For instance, JP Morgan Chase has targeted $2.5 trillion in investment as a necessary step toward aligning its portfolio with the Paris Climate accords. According to Jamie Dimon, chairman and CEO of JPMorgan Chase:
“Climate change and inequality are two of the critical issues of our time, and these new efforts will help create sustainable economic development that leads to a greener planet and critical investments in underserved communities.”
Many support ESG considerations and its implementation into business, as it brings light to social issues and the cost of doing business. Those supporters argue it has a positive effect on society by encouraging and celebrating businesses that balance profits with societal goals, while condemning businesses that engage in short-sighted practices with unsustainable social or environmental practices.
Those who oppose ESG argue that since there is no standardized approach to calculating ESG metrics, it is impossible to ascribe a certain monetary value to any individual factor. Additionally, opposers of ESG argue that its rise has caused a number of hedge funds and other investment-related organizations to focus on pushing a social agenda over their fiduciary duty, which is to produce the largest financial returns for their investors.
Triple Bottom Line
The truth may lie somewhere in the middle. “Triple bottom line” advocates argue that engaging in operations that are mindful of the external impact and practices of a business is at least pragmatic. Not only does the potential of a business (or the economy in which it operates) benefit from understanding the risks of dwindling resources, environmental risk, and social unrest, but the real potential for attracting investment, talent and political support has a significant potential for offsetting the cost of such long-term strategies.
Governmental Emphasis on ESG Consideration
Regardless of whether one supports ESG or not, ESG considerations seem to be here to stay. In 2021, President Biden signed into law the Uyghur Forced Labor Prevention Act – an act prohibiting the importation of specific products unless the importer could demonstrate the product was produced free from forced labor or human rights abuse. The SEC also began emphasizing ESG consideration and in March 2021 launched the Climate and ESG Task Force. The Task Force’s goal is to identify ESG-related misconduct. Specifically, the SEC is looking to tackle corporate marketing strategies, also known as “green-washing,” in which a corporation presents itself as “sustainable” or “environmentally-friendly” although it is not. Simply stated, mere window dressing will not cut it when presenting ESG as a component of selling ESG-oriented investments to the public.
Tangible ESG-related items (beyond the SEC task force and Biden) remain important even for critics. For example:
- Good governance is fundamental to a well-run organization, regardless of how one feels about the E and the S
- Good stewardship of the environment extends beyond carbon credits, as it helps companies mitigate supply chain risk from natural disasters, etc.
How Should You Build a Successful ESG Strategy?
First, it is important to remember that there is no one-size-fits-all strategy of any kind for any business. While strategic frameworks can be helpful in conceptualizing an internal strategy, the focus, measurable outcomes and resources allocated to an ESG program need to make sense, and yield benefits, to your business.
Though the degree of an ESG program may vary greatly, any business can benefit from asking the right questions and designing a useful, attainable plan.
Start with an internal evaluation
If nothing else, ESG factors are all about risk management. ESG factors are being used to evaluate companies’ exposure to and ability to withstand business and reputational risks. Factors to consider when considering your ESG success include:
- Environmental: is your company attempting to lower its carbon footprint; does your company use natural resources; is your company doing anything to conserve resources?
- Social: does your company have strong diversity and inclusion policies or focus; do you have a policy on modern slavery, particularly as it relates to the supply chain; do you have a supplier code of conduct?
- Governance: do your stakeholders have a say and is that say considered in decision-making; is there heavy board oversight; does the board consider ESG factors in voting?
How does an ESG program align with future goals?
Once you understand how your company currently addresses high-level ESG factors, consider whether implementing an ESG program aligns with the company’s broader strategy and sustainable success.
Questions to ask include:
What is the goal of the ESG program?
Understanding the company’s goals early is important to setting future expectations. Do you want to be a leader in the world of sustainability, or are you just interested in ensuring responsible operation?
Does the company have the resources to build an ESG program?
Depending on the size of the company and the goals sought, it may be important to appoint a high-level ESG champion to ensure long-term success. Creating an ESG program and then letting it fall by the wayside may risk the company’s reputation and is something to consider as the company advances.
What ESG risks and opportunities need to be managed and disclosed?
Creating an ESG program may require disclosure of certain risks or opportunities the company considers in the future. Different factors may affect different groups, for example, a diversity and inclusion policy change may affect your employees, while increasing supply chain costs may affect stakeholders and customers.
How will our ESG strategy improve the strength and effectiveness of our business?
If your company’s ESG strategy succeeds, how will it impact the bottom line? For instance, will it allow you to vie for specific market segments? While it help to mitigate real risks for you or your customers? Will it attract and retain the talent you are looking for? Again, there are no universal answers to these questions, but each business has its own individual opportunities related to a right-sized, focused and tangible ESG commitment.
Create a governance plan
If you decide the implementation of an ESG program will be beneficial to your company, creating your program is next. The company should appoint management-level employees to establish the costs and benefits of an ESG program, determining measurable outcomes and manageable objectives. In addition to an ESG committee, a company should also have board oversight to consider how initiatives align with board fiduciary obligations, how ESG information should be disclosed, and management of program objectives.
Generate a more comprehensive inventory of internal efforts
With ESG program objectives identified, key performance indicators and measurable metrics should be identified including a determination of how data can be collected and evaluated. To determine risks, opportunities or possible issues, company leaders should compare program objectives with available industry standards to determine what factors are most crucial to their industry. For instance, program objectives and outcomes can be compared to the SASB Materiality Finder. The better data a company has, the better it may understand and assess the challenges of the program. Importantly, the company should consider what it already does to meet ESG standards and what more can be achieved in the future.
Implementing your plan
Once you have completed your inventory of potential initiatives and collected data on your company’s current practices, disclose what you have found. Consider investor and stakeholder priorities and disclose information that investors or stakeholders will deem valuable. All disclosures come with risks that must be considered, such as legal repercussions relating to:
- Securities laws
- Consumer Protection and Anti-fraud laws
- Record requests
- Class actions
- Fiduciary duty requirements
Plan or No Plan – ESG Considerations and Planning for the Future
Company organization, size and industry are only a few of the important factors to consider when determining what ESG objectives will make sense for your company. A company may have a wide variety of options when implementing ESG objectives into its business, but the key is to attempt to select those that align with, compliment and are achievable for your business. Program impacts could range from basic operational practices to supplier requirements to investment strategies; the key is that they are meaningful and tenable for your business. Regardless of your company’s future goals, it is important to seek professional advice on your specific industry and the risks associated.
For more information or to discuss ESG questions, please contact KJK Corporate & Securities attorneys Ted Theofrastous (TCT@kjk.com; 216.736.7290) Christopher Hubbert (CJH@kjk.com; 216.736.7215), Samir Dahman (SBD@kjk.com; 614.427.5750) or Emily Stoerkel (ELS@kjk.com; 216.736.7257).