Growing evidence suggests that corporate focus on ESG—Environmental, Social, and Corporate Governance—may offer short- and long-term advantages to both companies and investors. These advantages are in addition to and apart from the residual benefits to society-at-large that may be created by a company with a strong ESG performance.
While some may view ESG as a set of factors used solely by socially conscious investors to screen potential investments or environmentalists to pressure a company into changing its operations, ESG is becoming an increasingly mainstream set of criteria. Investors are starting to focus on ESG to forecast and manage risks, and corporate leaders are looking to ESG for marketing and production efficiency.
What is ESG?
ESG stands for Environmental, Social, and Corporate Governance. The term refers to the three central factors in measuring the sustainability and societal impact of an investment in a company. For many, the term ESG brings to mind environmental issues like sustainability, climate change, and resource scarcity. These issues form an important element of ESG, but ESG means so much more. The environmental pillar of ESG looks at how a company performs as a steward of the environment. The social pillar examines how a company manages its labor practices, talent, product safety, data privacy, and relationships in its local communities. The governance pillar deals with a company’s leadership, executive and board compensation, internal audits and controls, anti-corruption, and shareholder rights.
ESG criteria may help to better determine the future financial performance of companies by balancing risk and return in the context of how a company’s business handles or interacts with these environmental, social, and corporate governance issues.
Recent Federal Activity
Despite this increased focus, some may still believe that ESG is not mainstream enough to justify spending limited corporate time and resources on it. For companies that are subject to regulation by the U.S. Securities and Exchange Commission (SEC), that perception may be changing. The SEC issued guidance in 2010 advising companies to disclose climate change-related developments that are material to their businesses. But that guidance does not carry the force of law, and it gives companies leeway to decide what is and is not material. The disclosures can either paint a rosy picture (when a company is likely to save money by switching to renewable energy) or a gloomy one (when a company has operations in flood zones that are facing rising waters). Currently, companies also do not have to reveal any quantitative data about their greenhouse gas emissions to the SEC.
However, the SEC recently announced that it would increase scrutiny of how thoroughly companies evaluate and disclose ESG risks, specifically climate change, and the impacts such risks may have on operations. The SEC’s new Climate and ESG Task Force will seek to uncover wrongdoing by looking for gaps or misstatements in a company’s reporting about climate risks under current rules. In addition, the Task Force will look for potential disclosure and compliance problems concerning the ESG strategies of investment advisers and funds.
In addition to creation of the Task Force, both the Acting Chair of the SEC and President Biden’s nominee to chair the SEC have signaled that establishing a mandatory, comprehensive framework for public company reporting of ESG issues could be forthcoming.
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