There is much confusion about terms like Sustainability and ESG. At first glance, the two terms look exactly the same. However, that is not completely true. ESG and Sustainability are similar and related but definitely not exactly the same.
ESG stands for Environmental, Social, and Governance while Sustainability tends to talk about EES or Environmental, Economic, and Social Sustainability. Of course, that is not the main difference. ESG tends to be more focused on Financial and Investment Risks due to ESG factors, while Sustainability tends to focus more on the actual results of the various sustainability measures that the organization has taken. In simple terms, Sustainability is more connected to the annual Sustainability Reporting and the use of Reporting Standards like GRI and ESG is more connected to ratings that are given by independent agencies to indicate the ESG risks an organization has. However, both have a similar purpose; to indicate how well the organization has been performing in the area of Environmental, Social, and Economic Sustainability.
The Importance of ESG for an organization
As already mentioned, ESG stands for the Environmental, Social, and Governance performance of the organization which focuses on how well the organization is doing in these areas within its industry. ESG, unlike Sustainability Reporting, tends not to focus on absolute numbers but more on ratings given by independent agencies that indicate the ESG performance of the company.
Some of the more popular rating agencies are FTSE Russell, MSCI, Sustainalytics, and many more. Each of these agencies has its own methodology or rating companies on their ESG performance. Some of them will use 1 to 4 stars (FTSE Russell) or CCC to AAA rating with AAA the highest rating (MSCI).
The overall rating consists of factors in the 3 areas Environmental, Social, and Governance. Environmental factors will focus on things like carbon emissions, waste and waste water, energy consumption, etc. Social factors will include Health & Safety, Product Safety, Human Capital Development, etc. Lastly, Governance will look into Board composition and diversity, Board independence, Business Ethics, and Tax transparency. Again, the actual detailed factors might vary slightly from one rating agency to the next but they are all focusing on the main issues.
All ratings are based on the type of industry the company is in and how well is the company performing in comparison with its peers in the same industry. This industry specificness is important because you cannot compare the ESG performance of an Oil and Gas company like Shell with the ESG performance of a pharmaceutical company like Pfizer or a bank like Maybank. The rating agencies will also look at different factors for the different industries. Greenhouse gas emissions might be an important factor for industrial companies like Shell and Pfizer but not for a bank like Maybank, while for a bank customer data protection might be an important factor for the rating.
As mentioned, all rating agencies have their own, proprietary rating methodology but they all serve the same purpose; to give potential investors an indication of how risky their investment would be if they would put their money in a certain company and that is exactly the reason why companies need to start paying attention to their ESG performance as more and more institutional and also individual investors include ESG ratings in their decision process.
A good example is the FTSE4Good Indices which are compiled and published by FTSE Russell. In Malaysia that would be the FTSE4Good Malaysia Index in cooperation with Bursa Malaysia or in ASEAN the FTSE4Good ASEAN 5 Index. The FTSE4Good Indices tend to include listed companies that are rated with 3 or 4 stars. Companies with less than 3 stars will not get onto the FTSE4Good index. In Malaysia there are 2 indices; the normal FTSE4Good Index and a Shariah Compliant Index.
Many companies are trying to get on this or other indices because they know it is good for business and it is expected that more companies will start paying better attention to their ESG rating and performance because of that.