Responsible investment terms: what is ESG?

Environmental, social and governance (ESG) is a term used to describe the overarching areas that characterise a sustainable, responsible or ethical investment.

Environmental and social issues are not incompatible with making a profit. This revelation became evident as early as English industrial revolution, when pioneers of responsible business fought for fairer treatment of workers and protection of the environment.

When Robert Owen bought New Lanark factory in Scotland in the 19th century and decided to prioritise the wellbeing of the locals rather than the maximisation of profits, something in the way money was made started to change.

Some call it investment philosophy, others core values, but usually it is summed up in three few words: environmental, social and governance (ESG).

Put simply, this term means that when a business wants to act responsibly and sustainably, it decides to take action in various areas of interest in order to give value to its investors.

ESG outlines the main areas of concern that a company might want to take into account before deciding to invest.

As can probably be deciphered from its name, the three overarching fields make up the sustainability of a business.

Climate change and pollution have started to affect business and investment too and it is widely accepted that human activities should avoid having a negative impact on the environment.

The environmental concerns that companies might deal with are vast, but the most targeted are the research about the effects of climate change, the disposal or toxic or industrial waste, the use of energy by preferring renewables to other, dirtier sources and more generally all the efforts made to become greener.

An example of ESG is the commitment by the Co-operative Group to cut its water consumption and greenhouse gas emission by 40%, as published in its recent ethical plan.

ESG also refers to the responsibility that a business has towards other people and communities: human rights, equal opportunities and animal welfare, for example.

Finally, the corporate governance aspect covers the management of a company, such as its responsibilities towards its staff, customers and shareholders. It aims to balance power relations inside the company and ensure that the rights and ethical codes are respected.

ESG is a core element of sustainable investment because it defines its criteria and strategies. It also gives a framework for it to operate in, by excluding certain areas in order to promote other more responsible and sustainable companies and industries.

Further reading:

Investment reports reveal widespread use of ESG integration

Poor ESG records scupper private equity deals

PRI signatories pick out top ESG engagement issues

The Guide to Sustainable Investment 2013