What exactly is ESG: All you need to know about the 3 key factors that define the growth of an organisation

Environmental, Social and Governance (ESG) are three important factors that help in understanding sustainability and societal impact of an investment in a company

Shailesh Haribhakti Srinath SridharanUpdated: Thursday, May 13, 2021, 02:08 AM IST

Environmental, Social and Governance (ESG) refers to the three core themes in measuring the sustainability and societal impact of an investment in a company. These criteria also help in determining the future financial performance of companies.

Environmental, Social and Governance (ESG) issues concern and impact every company, irrespective of where the company operates. Environmental issues range across climate change, carbon emission concerns, waste management, pollution (air and water). Social issues range across labour issues, modern slavery, under-the-table sourcing practices, product liabilities, privacy concerns, data security. Governance issues range across business ethics, corporate culture that shapes how a company functions and its organisational practices, board impact, enterprise risk framework, granularity of the organisation disclosures.

For those hearing the word ‘ESG’ for the first time, does it sound like the latest three-letter word? Or a fancy jargon? And for those using the term ‘ESG’ loosely as a way to sound nice, some points to ponder:

  • How do you improvise the existing ESG standards?

  • How do you improve the existing processes that impact ESG performance of your firm?

  • How do you compete with the global benchmarks?

  • How do you prove to be a pioneer in your industry / geography / globally?

The term ESG was first coined in 2005 in a landmark study initiated by United Nations, titled as ‘Who Cares Wins.’ ESG will play a vital role in the very-existence, growth and sustainability of purpose-driven companies. It is no longer just about maximising profits, but also about using sustainable supply-chain practices to ensure long-term growth and longevity.

Social License

Sustainability is not a main stream story yet, especially in most of Corporate India. It cannot be just a few pages tucked inside the annual report. Sustainability is specific to a company, or an industry and to a country. Companies need to measure their positive and negative impacts, identify the baselines, and disclose in a transparent and consumer-friendly manner. Regulatory requirement of such disclosures have compelled the act of disclosures, but not necessarily the spirit and details of such disclosures.

A social licence simply refers to the acceptance of an organisation by the community in which it operates. In other words, it is the ability of an organisation to carry out its business, simply because the confidence the (local) society has, that it will behave well respecting all rules and traditions, with accountability and in a socially and environmentally responsible way. The ‘social license to operate’ is made of these three elements:

Legitimacy: The extent to which an organisation operates by the ‘rules of the game’ (the norm of the community, even if they are informal or not coded as law).

Credibility: The organisation’s ability to provide true and detailed information to the community and fulfil all its commitments on time, without reminders.

Trust: This aspect of highest quality of a relationship takes time and effort to nurture and sustain.

Organisations which think that social licence is something that they can “pay for”, end up with their credibility at stake. Companies with questionable processes try and “buy such credibility” by giving out community grants (in the form of social funds). This kind of transactional nature of the behaviour would break any trust that the community has with the organisation. Even a broken relationship can be mended or healed by carefully rebuilding that trust.

Social license of profit-making entities has to be a full-time engagement. Organisations which champion their community-initiatives, usually have their best and senior resources overseeing those initiatives. Such organisations ensure that their Boards are appraised regularly of the initiatives, however small the projects could be in their balance sheet. It is the guiding principles of those initiatives, which matter and not the project-cost-outlay.

Net-Zero by 2035

‘Net Zero Emissions’ is a term in usage since the Paris Agreement in 2015, where many governments agreed to their commitments to achieve net zero emissions by 2050. Net zero means achieving a balance between the greenhouse gases put into the atmosphere and those taken out.

A country just cannot deliver its net-zero promise, unless it transforms its entire industries way of operations as well as the economy. With regulations seeking those changes, businesses are increasingly coming forward with net-zero commitments.

It is natural for many businesses globally to “wait and watch”. And, in today’s global economic situation, many business leaders could simply procrastinate and postpone taking large call for investments towards Net Zero challenge.

As history has shown, as the countdown to the Net Zero tightens, the polity and policy leaders globally will start taking decisions on behalf of corporate leaders and force tougher regulations and tighter sanctions including huge monetary penalties.

ESG magic

To really achieve sustainability, it has to be a top-down, company-wide cultural effort. There are many firms that “rate” the ESG initiatives of entities. Most of them have opaque attributes whose count and quality differs between their industry counterparts. It is surprising that globally the rating agencies have not come together to have a unique global framework including attributes.

“What you measure is what you get” — If you measure the wrong attribute, you can make the data look good in the final interpretation. Standardisation is key for creating a common language and benchmarks, and therefore a need for transparency. That’s where critical stakeholders have to showcase the hallmark of ESG — “transparency”.

And, this is also where the ESG detractors or naysayers go wrong; however rich and popular they may be. ESG measurement cannot be just a number, but has to be seen in context of qualitative parameters too. Addressing all ESG concerns at once is nearly impossible even for the most forward-looking and well-intentioned companies. The key to success is materiality. The understanding of which ESG risks are relevant to a company’s sector and overall operating context is important.

While ESG seems to be a black box to some, it looks like the magic moment for many. It’s not as easy as getting the company rated and just spouting the “ESG pride”.

ESG: Bringing voices together

The first observation on “social licence to operate” debated the intersection of corporates and communities. The net zero observations debated the intersection of governments globally and corporates. The ESG measurement is about the assessment of individual corporate. Whereas, a successful ESG-way-of-life would be possible only when we have the above three intersect, and work in tandem.

A productive ESG thinking depends in building initiatives that are authentic, inclusive, actionable and focused on driving a real-world result, not just an ESG rating or award. ESG is not a revolution, but more a mindset-evolution. Just as how an ECG can detect heart condition and potentially save lives, ESG assessment can foretell organisational health. Capital, human capital and social capital have to come together for impactful ESG outcomes.

In this transformational journey to make the world ‘good’, every voice counts and every positive act matters. Conversations around ESG need to move out of specialist journals, multilateral institutions' annual summits and corporate board rooms to classroom debates, panchayat discussions, and populist mass media across various languages.

(About the writers: Shailesh Haribhakti is a renowned Chartered Accountant, and Srinath Sridharan is an independent markets commentator)

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