What is ESG and why does it matter?

Company executives and professional advisers frequently receive communications urging them to take action on ESG, so that their companies or clients do not suffer commercial disadvantage; “Can you risk not committing to ESG?” is one example. Many people active in the commercial world may have only a hazy idea of what ESG means.

What is ESG?

ESG – Environmental Social and Governance – is a system review of corporate management which evaluates the effect of the operation of a business on its employees and the community as a whole, in terms of social and environmental impact. Previously, it was Corporate Social Responsibility – a measure of how a business performed in terms of its social and philanthropic works – for example, giving back to the community. ESG goes further and looks at the effect of a business’s impact on the environment too.

However, there is no mandatory requirement for ESG as such. There are some regulations which affect certain sectors of business; there is a code of conduct for listed companies; and there are statutory requirements setting out directors’ duties, but nowhere is there a codified system of compliance for ESG. The best that can be said for ESG is that it is an initiative for good and transparent corporate governance.

The three pillars of ESG

The three pillars of ESG are:

1. Environmental: greenhouse gas emissions, energy use, water consumption, waste generation, climate change impact;
2. Social: employee satisfaction, supplier diversity, customer satisfaction, community impact, human rights;
3. Governance: board diversity, executive compensation, ethical practices, compliance with laws and regulations.

All of these are ideals which are within the purview of most responsibly run businesses and do not impose a substantial additional burden on management. No responsible organisation would wish to be known as an incontinent polluter, a poor employer or one which habitually disregards laws and regulations, and so the publication of an ESG strategy will not require a radical departure from normal business practice.

Nevertheless, in some areas there are legal requirements which fall within the scope of ESG. There is a statutory requirement that company directors must act in a way which promotes the success of the company for the benefit of its members as a whole, but in doing so they must also have regard to:

• the likely consequences of any decision in the long term;
• the interests of the company’s employees;
• the need to foster the company’s business relationships with suppliers, customers and others;
• the impact of the company’s operations on the community and the environment;
• the desirability of the company maintaining a reputation for high standards of business conduct; and
• the need to act fairly as between members of the company.

Medium and large companies are obliged to produce an annual strategic report showing how the directors have complied with those obligations. Larger companies are required to provide details of the impact on the company of climate-related risks and opportunities. Quoted companies are required to include details of the company’s energy consumption and greenhouse gas emissions in the directors’ report. All employers with more than 250 staff are required to publish an annual report setting out the differences in pay between male and female staff. Businesses with a turnover in excess of £36 million are obliged to produce an annual statement setting out the steps they take to prevent modern slavery in their business and their supply chains.

ESG: a marketing ploy?

If there are already laws and regulations, albeit rather piecemeal, which cover issues that lie under the ESG umbrella, is it necessary to have a separate ESG initiative? A discrete policy statement has its merits, so long as ESG is used as a measure of improvement, rather than simply as a marketing exercise.

The rationale is that all businesses have to have an ESG policy in order to attract customers who won’t want to do business with companies who don’t have a policy implemented – or one which is not effective. Essentially, if you don’t have an effective ESG policy, your business will suffer.

In the 1990s there was a similar message in respect of quality management system: if your organisation was not registered for IS09000, you would lose customers or you might be ineligible to tender for business. Many companies jumped on the IS09000 bandwagon even though it might not have been appropriate. As the objective was to have a system, any registered system in place would suffice, even if the quality of management measured by the system was not great. Form was more important than substance. This should not be the pattern for ESG.

The UK’s common law system, whereby laws are contained in a multitude of statutes and regulations, results in something of a legal paperchase when trying to link all of the associated laws together. If, as is anticipated, ESG becomes more formalised with additional legislation and regulation, it would be desirable to amalgamate all of the legislation in a single code to produce a unified and coherent statement of the relevant law. In the meantime, the ESG threads must be pulled together manually.

Given that there are already legal requirements which fall within the compass of ESG and that the general principles of ESG are desirable in a well-run and responsible business, there is a benefit for an organisation having a specific policy document setting out the various aspects of its ESG initiative, both mandatory and voluntary. By implementing one policy, things become clearer and more comprehensive and reflect a statement of the company’s values. If it also serves to boost the company’s image, then perhaps that is no bad thing.

If you have questions about ESG policies in your company, please contact Stephen Kingsley.