Original: January 2023; Updated: January 2024
The term “ESG” first appeared in a report titled “Who cares wins", published in 2004 under the guidance of the UN Global Compact. The subtitle of the report, “connecting financial markets to a changing world,” highlights its intention to provide guidance for financial institutions on environmental, social, and corporate governance issues which are seen to be closely related to sound financial resource allocation. The report is the output of a joint initiative of 18 leading financial institutions from 9 countries at the invitation of the UN Secretary-General Kofi Annan.
An excerpt from the Executive Summary clearly outlines why these global financial institutions chose to endorse this report. It states that “The institutions endorsing this report are convinced that in a more globalised, interconnected and competitive world, the way that environmental, social and corporate governance issues are managed is part of companies’ overall management quality needed to compete successfully. Companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory actions, or accessing new markets, while at the same time contributing to the sustainable development of the societies in which they operate. Moreover, these issues can have a strong impact on reputation and brands, an increasingly important part of company value.” Thus, matters of ESG are important and relevant for investment and business operations because of their tangible impact on business performance and investment return.
The report's ten Principles provides the reasoning and foundation for the case examples highlighted in the report. These principles cover the topics of Human Rights, Labour, Environment, and Anti-Corruption, and they are
The report argues that “successful investment depends on a vibrant economy, which depends on a healthy civil society, which is ultimately dependent on a sustainable planet.” In these few words, it succinctly links concepts across the financial sector which allocates the resources, the various other economic sectors which contributes to economic growth, civil society which ensures appropriate conduct of individuals and entities, and the planet which incorporates nature and environment. It further reasons that “A better inclusion of environmental, social and corporate governance (ESG) factors in investment decisions will ultimately contribute to more stable and predictable markets, which is in the interest of all market actors.”
The report explicitly refrained from terms such as “corporate citizenship” in favour of spelling out the “environmental, social, and governance issues” which have or could have a material impact on investment value. A broader definition of “materiality” including a longer time horizon and intangible aspects leads to generally accepted principles (such as the UN Global Compact Principles) and ethical guidelines that can have a material impact on investment value.
The report lists a set of ESG topics that, at that time, were hypothesised to have material impacts on companies. This list, which includes climate change, the need to reduce toxic releases and waste, community relations, executive compensation, and management of corruption and bribery issues, seems as relevant today as it was 20 years ago. It also highlights a number of problems concerning ESG matters, and they include clear definitions, making and measuring of the business case, skills and competencies. As an ESG enthusiast and professional, refreshing our understanding of this report in the context of today's environment helps to remind us of how and why this all started.
Since the publication of this report, the field of sustainable finance has blossomed. Increasingly, financial institutions are looking for robust data and models on environment, social and governance (ESG) topics to support their product design and offerings. This has led to the growing need for data, scenarios, models and standards related to these topics. Across the three dimensions of ESG, environmental topics are the most mature in its development with awareness of the realities of climate change becoming ever more apparent across the spectrum of economic activities. Climate-related standards developed for financial disclosures by the Taskforce for Climate-related Financial Disclosures (TCFD) is widely adopted by industry and is now incorporated in legally binding regulations such as the EU's Corporate Sustainability Reporting Standards (CSRD) and international consensus like the International Sustainability Standards Board (ISSB). Taskforce on Nature-related financial disclosures (TNFD) released its first draft in November 2023, creating transparency around nature-related actions and impacts. Climate-related physical and transitional risks are being estimated with ever more sophisticated models tailored to activities in different economic sectors.
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