A guide to ESG: what is it and why does it matter?

Posted on: 25 September, 2024

ESG has grown from a small CSR initiative into a global business priority and a multi-million-dollar industry. Here’s why it matters.

The factors that determine success for a company have changed. While historically, financial profit has been (and for the most part remains) the most important benchmark, shifts in the attitudes of incoming generations and increasing legislation from governments have forced organisations to reassess how they position themselves and what they prioritise.

Today’s customers don’t just care about the quality of a brand’s products or services – they care about their ethos and the way they conduct business behind the scenes. Research by Finder discovered that 76% of UK customers will stop buying from companies that don’t care about how they treat the environment. The same survey also found that 80% of consumers will be more loyal to companies that support social and environmental initiatives.

Environmental, Social and Governance (ESG) practices have emerged out of this shift in order to provide organisations with a reporting framework on which to measure (and address) their impact and contributions to the betterment of society. But what exactly is ESG? Why is it important? And how can businesses report on their success?

What is ESG?

ESG is a set of standards, policies and metrics used by organisations and investors to assess both the societal and environmental impact of their operations. For businesses, it’s a way to prove to investors, employees and customers that they’re acting in the interests of the planet and society. For investors, ESG can help screen potential investments for risk.

ESG looks at the following areas across the environment, society, and governance:

ESG originates from around 2004 where it was first coined by Global Compact. Since then, it has grown from a Corporate Social Responsibility (CSR) initiative into a thriving market and a chief priority for modern corporations and enterprises.

Today, ESG is at the forefront of decision-making – two-thirds of investors take it into account in their investment decisions, according to CBI, while 88% of public companies have some kind of ESG initiative in place. The market for ESG software is expected to grow at a compound annual growth rate (CAGR) of 18.3% between now and 2030, reaching as much as USD$2,340 million by the end of the decade.

Why ESG is here to stay

As the above statistics illustrate, both corporations and investors value ESG. In the current business landscape, it’s a non-negotiable for an aspiring company to have some sort of ESG initiative in place if it wants to attract the investment it needs to grow.

Incorporating ESG initiatives can help business leaders identify and mitigate potential risks that could have a significant impact on their organisation’s reputation, profit, and operations. Take the Volkswagen emission scandal, for example – a situation that could have been avoided by proper implementation of ESG policies.

ESG has also been linked with improved financial performance. A review of over 1,000 studies over a five year period by NYU Stern found that 58% of corporate businesses experienced a positive relationship between ESG and financial performance. What’s more, research from McKinsey found that ESG strategies can impact operating profits by as much as 60%.

In the aftermath of the pandemic, resilience is also a central priority for modern businesses, and this is something that ESG can strengthen. Extreme weather events caused by climate change have cost EU businesses €650 billion between 1980 and 2022. Globally, this figure is expected to reach $1.3 trillion by 2026, emphasising the importance for organisations to become future-ready and develop operational adaptability.

How do you report on ESG?

ESG reporting is how organisations disclose data on their business activities and perceived risks across environmental concerns, social issues and corporate factors. This is done to improve transparency among investors, key stakeholders, customers and employees and prove they’re not attempting to greenwash their operations.

The success of their initiatives can be given an ESG score by rating agencies such as Bloomberg and Dow Jones, which is measured from 0 to 100. Anything below 50 is considered poor, while a score of 70 is deemed positive. Each provider will have its own rating scheme, meaning a company can receive different scores from different agencies.

For investors, ESG targets and scores are a useful tool to help screen potential investment opportunities, while customers and employees can benefit from this level of transparency when deciding who to do business with or work for.

Learn more: How to select the right ESG goals and targets for your business

7 benefits of implementing ESG

There are a wide range of benefits for companies that implement ESG initiative successfully, including:

1. Provides a competitive advantage

As illustrated above, monitoring ESG criteria can improve an organisation’s financial returns and resilience in times of uncertainty and change – all of which helping to create a competitive advantage over the rest of the market. It can also boost customer and employee engagement and loyalty, which is essential in a market of increasingly discerning consumers and job applicants. 88% of customers will be more loyal to businesses that support social or environmental issues, while organisations with ESG initiatives have higher employee satisfaction scores on average than their counterparts.

2. Improves risk management

Both investors and CFOs in business stand to benefit from ESG as it can help teams proactively identify potential risks, whether it’s to the environment, society, or their internal governance. An example of this could be reviewing an offsetting investment intended to negate their carbon emissions for potential negative perception from the public, or assessing the impact a recent climate disaster could have on operations.

Learn more: Building climate resilience into the built environment

3. Enhances portfolio performance

Integrating ESG into investments can both improve portfolio overall performance and mitigate potential risk. Portfolios that perform well against ESG criteria have been proven to outperform their counterparts, especially during times of uncertainty. In analysis conducted by Morningstar, almost 60% of sustainable funds outperformed their traditional peers over a 10-year period.

4. Better for sustainability

The environment is a central tenant of ESG, and as such, implementing ESG can help organisations have a positive impact on the environment and improve sustainability. Being able to adapt to changing circumstances and a shifting landscape can help teams address sustainability issues and find opportunities to reduce energy consumption, which can go a long way to saving costs in difficult and uncertain markets.

What’s more, with many investors using ESG initiatives to help them make informed decisions, adopting sustainable practices can be crucial to attracting the necessary investment needed to grow.

Learn more: Making a business case for sustainability: why now is the time to act

5. Aids recruitment (and retention)

Incoming generations care more about how a company operates and conducts itself than ever before, and no generation is a better example of that than Generation Z. According to one survey, 90% of Gen Z claim to have made changes to their lives to become more sustainable. Another study found that 73% would pay more for ethically sourced products and two-thirds (66%) for sustainable or environmentally friendly products.

With this in mind, adopting ESG initiatives can improve brand reputation and have a positive environmental and social impact. It won’t just be customers that are impressed, either – an IBM survey found that 71% of job seekers want to work for companies that are environmentally sustainable.

Learn more: Diagnosing the green skills gap: what skills is the built environment missing?

6. Supports innovation

There’s clearly a business case for sustainability and a growing demand for sustainable products and services from customers, employees, and other businesses alike. And in a field where our understanding is constantly shifting and evolving, this means there’s an opportunity for innovation. Adopting ESG principles can help businesses bring new propositions and products to the market that satisfy this desire fort sustainability.

7. Impacts and supports supply chain relationships

Investors and younger generations aren’t the only groups paying attention to ESG. Implementing these initiatives can have a knock-on effect on supplier relations too. Poor ESG performance won’t help to increase an organisation’s pool of customers for providers, as partnering with companies that aren’t prioritising sustainability can have a negative impact on their own ESG scores, too.

Learn more: The criticism of ESG: why is it becoming controversial?