Private finance is playing a hugely important role in the drive towards net-zero, and this is just the beginning. This article unpacks what ESG is and the role of the financial industry in promoting ESG, with a particular focus on the drive to net-zero, and why this is relevant to all businesses.
ESG stands for Environmental, Social and Governance. Using ESG criteria to inform investment decision-making means analysing and assessing the inherent value already present in companies and using this as a basis for the decision of whether to invest or not. The table below provides some examples as to what ESG considerations are; this is not an exhaustive list.
Financial institutions around the globe are responding to stakeholder demands and are increasingly placing weight on ESG criteria when making investment decisions. Two notable examples illustrate the increasing importance of ESG to the financial industry and businesses in general:
Although ESG data is not strictly ‘financial’ data, investors now see ESG as closely linked with business resilience, competitive strength, and financial performance. As a result, many investors are now including ESG criteria into their decision-making process when deciding whether to lend and invest money.
Accounting for ESG criteria is not currently mandatory for financial reporting, but companies are starting to disclose their ESG data in annual reports or in Sustainability Audits. This is a recognition of the importance of ESG data to investors and to society in general.
The importance of ESG is strengthening with every passing day and it’s becoming clear that business models must recalibrate. From the ‘Environmental’ perspective, credible plans to transition to a low carbon business model are needed. To do this, businesses must conduct a Carbon Footprint to identify and understand where in their supply chain they are producing carbon and how much is being produced. From there, businesses must incorporate actionable short-and-long-term plans to reduce such emissions into their business strategies.
There is currently no standard practice on how to assess ESG and incorporate it into investment decisions. This does not mean that it is not important. Moreover, it means that each investor incorporates ESG criteria into their decision-making process in a different way.
Industry experts are increasingly calling for standardisation; this would help improve how data is measured and define which non-financial data should be published by companies. A standardised system would also facilitate better understanding of how ESG factors influence investment decisions. Some industry experts are calling for non-financial data, like ESG criteria, to be regarded at the same level as financial data as this would harmonise and increase its credibility.
To thrive and secure the best investment, businesses should incorporate ESG criteria into their annual reports alongside ESG specific reports that address the complexities and nuances of different topics like emissions and waste. This data will help companies truly understand where they are in relation to their ESG aims and help them develop strategies to move them closer towards their goals. Final ratings are no longer enough: a deep dive into individual data points is necessary.
This is not an issue of marketing; it is about what matters financially, and more importantly, for society as a whole.
Efforts to Standardise:
Efforts to develop a standardised system to measure and assess business’ sustainability are in full swing. Global standards improve transparency by creating internationally comparable information, enabling investors and other market participants to make informed decisions.
IFRS has developed accounting standards that are required in over 140 jurisdictions and permitted in many others. They are building on this and in November 2021 announced the creation of a new standard-setting board – the International Sustainability Standards Board (ISSB). The ISSB are currently developing globally accepted sustainability reporting standards. Their aim is to ensure that accounting and sustainability standards are two parts of the same whole, which will improve corporate reporting overall.
Likewise, the EU is currently developing a proposal for a Corporate Sustainability Reporting Directive (CSRD) which will require larger companies to provide audited sustainability information. This will be coupled with the adoption of EU sustainability reporting standards.
There is still much debate as to what effective standardisation entails; it’s a decision that will impact all stakeholders. So, if you’re a business, no matter your size, think about what kind of standards would suit you and start the conversation! Standardisation should provide companies with direction not additional hurdles.
Recent efforts to include ESG criteria into financial decisions mainly relate to larger companies. SMEs are not currently obliged to make ESG disclosures. There are, however, many ethical banks like Triodos, Co-op and Starling, who emphasise the importance of ESG. It is also clear that ESG is here to stay, and it is only a matter of time before ESG standards and regulations trickle down to SMEs.
We spoke to Matthew Duckworth, Senior Relationship Manager at Triodos Bank UK, who told us about how Triodos works to finance companies that are making meaningful ESG related commitments. This is because sustainability in all senses – economic and social – can work hand in hand with the needs of your business.
“For over 25 years, we’ve been lending to UK organisations delivering positive social, environmental or cultural impact and our goal is to reach net zero across our own operations, loans and investments by 2035.
Our strategy is called As One To Zero, because if we’re going to reach net zero – and meaningfully address the climate crisis – we need to do it as one. This means reducing emissions while respecting our planet’s boundaries and achieving social inclusion for all. It means taking into account social and cultural considerations as we decarbonise and making sure this is a journey where no one gets left behind.
As such, we look beyond traditional ESG and instead focus on supporting organisations that are achieving a clear, measurable positive impact.
As a lender, this means increasing financial support to initiatives that conserve and restore nature, back renewable energy regeneration, retrofit our built environment and focus on transitioning vital services like healthcare and transport.”
SMEs can start the process of collecting ESG data and improving their performance by:
This is an opportunity to be ahead of the curve, rather than waiting to be forced to do so.
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