What is ESG and does it make financial sense for businesses?

by Matt Blomberg | @BlombergMD | Thomson Reuters Foundation
Thursday, 3 June 2021 09:45 GMT

A child walks under a banner as hundreds of teachers and supporters march, days before the teacher's union was set to go on strike if a contract settlement was not reached, in Chicago, Illinois, U.S. October 14, 2019. Picture taken October 14, 2019. REUTERS/Brendan O'Brien

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Ethical investing, which weighs up companies' commitment to environmental, social and governance issues - or ESG - has become one of the fastest growing areas of finance

By Matt Blomberg

PHNOM PENH, June 3 (Thomson Reuters Foundation) - From high fashion factories in Cambodia to slaughterhouses in Germany, the COVID-19 pandemic has wreaked havoc on workers around the world - with outbreaks, mass layoffs and the rollback of workers' rights making the headlines.

But it is not all bad news. There has also been a significant push to rebuild workplaces and economies in a more sustainable way that puts people first.

In fact, in March last year, a group of 286 investors representing more than 8.2 trillion dollars in assets, called for companies to keep jobs, provide paid leave and prioritise health and safety.

What is ESG?   

Ethical investing, which weighs up companies' commitment to environmental, social and governance issues - or ESG - has become one of the fastest growing areas of finance.

It covers a range of issues from the diversity of a workplace to its carbon emissions.

"It could be privacy, freedom of association, freedom of expression, access to water, nutrition, labour rights," said Caroline Rees, co-founder and director of Shift, a non-profit working at the nexus of business and human rights.

Until now companies have often focused on the E because of the long-term risks posed by climate change.

But analysts say that things have started to change – with the emphasis shifting to the S.

A mining company, for example, would consider whether its operations could displace a community, cut off access to hunting grounds, or poison drinking water - concerns that previously belonged primarily to governments.

"It's a threshhold. When you hit that level that it undermines people's basic dignity and equality ... that's when companies need to be taking action," Rees said.  

Does it make financial sense?

Yes it does, experts say.

The market tends to reward companies that minimise their exposure to risk, as opposed to firms that sell controversial products or use an insecure labour force, for example, which can hurt profits and increase volatility.

"Studies have shown that managing social factors such as diversity and inclusion, and human capital management, have a strong investment case," said Michael W. Frerichs, the Illinois state treasurer in the United States.

Firms that roll back safety conditions or benefits for workers risk creating an environment where staff are more likely to strike or become less productive, he said.

"Although those decisions to cut costs might make you profitable in the next month or the next quarter, they could lead to an erosion in value of your company long-term."

For example, shares in food delivery app Deliveroo plunged by as much as 30% in their stock market debut in March, Britain's biggest in nearly a decade, after some top investment firms stayed away, citing a lack of rights for riders as an investment risk.

How do you measure the impact of ESG?

While environmental impact assessments have become standardised, a company's impact on the people and communities around it - and their efforts to offset negative effects - can be more difficult to track and pin down.

For years, companies have been able to make grand public declarations on their commitments with no clear or universal standards to which they could be help accountable.

But an increasing number of regulators - and almost all stock exchanges - now call for disclosure on social impacts, putting their claims to the test, said Bastien Buck, chief of standards at the Global Reporting Initiative.

"Sometimes they focus on single issues, some embrace certain international issues and others have a more holistic view," he said, calling for the S in ESG to be standardised and written into law.

"It needs to move from voluntary to mandatory, eventually. If you mandate this type of disclosure, you are taking care of many issues."

As billions of dollars is pushed into rebuilding economies around the world, firms have the perfect opportunity to ensure that human rights become a fundamental part of business models in the future, experts said.

For example, as businesses embrace remote work as a long-term solution, some companies are giving employees the right to disconnect.

Others like Buy-now, pay-later firm Zip, challenger bank Monzo, TV network Channel 4, Barking & Dagenham council and Wonderhood Studios, an ad agency, have recently offered employees some form of compassionate leave after a miscarriage.

"We cannot expect business to thrive financially, reputational, or in any other regard, unless these practices change and respect for people becomes routine to the ways in which business gets done," said Rees.

Related stories:

INVESTIGATION: Inside Amazon's shadow workforce in Mexico  

INVESTIGATION: Risks for South Africa's food couriers surge during the pandemic

OPINION: Companies and investors need to prioritise human rights long after the pandemic

(Reporting by Matt Blomberg @BlombergMD, Editing by Lin Taylor @linnytayls. Please credit the Thomson Reuters Foundation, the charitable arm of Thomson Reuters, that covers the lives of people around the world who struggle to live freely or fairly. Visit http://news.trust.org)