Environmental, social, and governance (ESG) criteria comprise a set of standards socially responsible investors use to evaluate a company based on three main criteria: environmental, social, and corporate governance. Combined they help assess the social responsibility effort of companies in the marketplace.
Understanding ESG criteria
Climate change, social unrest, and the coronavirus pandemic have also increased awareness about the interconnectedness of sustainability and the financial system.
In response to these trends, brokerage firms and mutual fund companies now offer exchange-traded funds (ETFs) and other financial products that respect various environmental, social, and governance criteria.
Data released by The Forum for Sustainable and Responsible Investment shows the total US-domiciled assets under management using sustainable investment strategies reached $17.1 trillion in 2020.
This figure constituted around 33% of the total assets under professional management in the United States.
While rarely mentioned in mandatory financial reporting, many investors evaluate ESG criteria to better understand the various companies in their investment portfolio.
Indeed, investors consider companies that share their values and concerns about the world, with the profitability and risk of the company a secondary concern at best.
In the following sections, we will discuss some specific criteria for each category.
Before we proceed, however, it should be noted that there is no exhaustive or definitive list of ESG criteria. Furthermore, some criteria are interrelated and it can be difficult to assign one to a single category.
Environmental criteria deal with the conservation of the natural world and external factors not affected by market mechanisms that can impact company revenue.
- Air and water pollution.
- Waste management.
- Climate change and greenhouse gas emissions.
- Biodiversity, and
Microsoft recently became the first company among its peers to target a “carbon negative” status by the year 2030.
To that end, the company created a $1 billion fund to reduce emissions and remove all the carbon it has emitted since it was founded in 1975.
Social criteria encompass the various relationships a company has with people, institutions, and communities.
Since every company operates within a broader society, the way in which it carries itself is critical to attracting socially responsible investors.
Examples of social criteria include:
- Customer satisfaction.
- Community relations and involvement.
- Human rights.
- Employee engagement, and
- Data protection and privacy.
Graphics card manufacturer NVIDIA has a strict policy to never use conflict minerals in its products.
The company’s Conflict Minerals Policy ensures that gold, tantalum, tungsten, and tin purchased from the Democratic Republic of Congo do not directly or indirectly finance armed militia groups.
Corporate governance criteria
Corporate governance criteria are assessed by investors to ensure the company uses accurate and transparent accounting methods, avoids potential conflicts of interest, and allows shareholders to vote on important issues.
Governance criteria include:
- Bribery and corruption.
- Executive compensation.
- Shareholder rights.
- Political contributions and lobbying.
- Audit committee structure, and
- Hiring and onboarding best practices.
Pharmaceutical giant GlaxoSmithKline (GSK) is working toward at least 45% female representation in senior roles before the end of 2025.
Construction and infrastructure company Emcor Group is also known for giving employees unprecedented encouragement to raise potential ethics breaches.
- Environmental, social, and governance (ESG) criteria comprise a set of standards socially responsible investors use to evaluate a company. Younger investors are considering ESG criteria as the basis for investment decisions, with less credence given to profitability or risk.
- Environmental criteria encompass the natural world and external market mechanisms, including water pollution, air pollution, climate change, waste management, and deforestation.
- Social criteria describe the relationships a company has with wider society and the reputation it earns as a consequence. Governance criteria, on the other hand, may include executive compensation, shareholder rights, and recruitment best practices.
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