What Is ESG Performance And How To Measure It?
ESG practices are important to various stakeholders, including consumers, business leaders, employees, investors, and communities alike. However, unlike with profitability, comparing ESG performance between companies, or over time within a company, is challenging. By using appropriate data, you can establish and enhance your company's position as a leader in ESG practices.
What is ESG Performance?
The crucial first step is to clearly define what we mean by ESG performance, as there can be varying interpretations. Additionally, each company may prioritise different aspects of environmental, social, and governance issues based on their values or suitability. Furthermore, measuring ESG performance is challenging, as it may be difficult to quantify certain actions, such as reducing pollution. Nonetheless, various methods exist for measuring ESG considerations.
ESG stands for environmental, social, and governance values, and ESG performance is a measure of how well a company is adhering to these criteria. Investors use this measure to make decisions and compare brands with each other. Additionally, potential consumers and employees use ESG performance to assess if a brand is aligned with its values before engaging with the brand.
Investors typically use three approaches to compare ESG ratings:
Comparing ratings with peers who manage similar portfolios.
Using a standard industry benchmark index.
Relying on their own historical and internal data.
Different approaches have their own limitations and their suitability depends on various factors such as the level of risk involved in the portfolio, stakeholder composition, and fiduciary responsibilities. Also, comparing ESG performance is not straightforward as there can be significant variations in ESG ratings across industries, companies, and metrics.
Why ESG Performance Matters
The data indicates that ESG performance is significant and should not be disregarded.
A recent report shows that 83% of consumers believe that it is important for companies to adopt ESG best practices. Additionally, 91% of business leaders feel that they have a responsibility to address ESG issues. Furthermore, 86% of employees prefer to work for a company that shares their views on such issues. By this rationale, and if we view the bedrock of any company’s success as the people who form it, ESG in some form is the direction companies need to take to find growth pathways that align with a changing world.
The data reveals that when it comes to making purchasing decisions, consumers between the ages of 17 and 38 are twice as likely as older consumers to take into account ESG issues. This is not just a matter of personal opinions or feelings.
ESG trends are being noticed by investors, as assets under management in ESG funds have doubled between 2017 and 2020. This shift towards ESG is being seen in both passive funds that track ESG indexes and activist funds that purchase the entire market and then advocate for ESG issues through shareholder voting. Even organisations that prioritise financial metrics need to comprehend the impact of ESG on their sales and capital-raising abilities.
Benefits of Measuring ESG Performance
Let's begin by discussing the benefits of ESG measurement before diving into its main methods:
ESG measurement and reporting can help reduce a company's operational costs. More data means more transparency and opportunity for improvement.
It is also important for enhancing a company's brand at both local and international levels.
ESG assessment and reporting are particularly useful for businesses seeking to gain support from their investors and customers.
Compliance with various regulations and policies necessitates ESG assessment and reporting.
Measuring a company's ESG performance assists in developing long-term strategic plans, preventing a reliance on short-termist thinking.
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How to Measure ESG Performance
There isn't a single factor that determines the success of a company's ESG initiatives. To measure ESG, both quantitative and qualitative indicators are used, and each industry requires a customised approach. These are the essential steps for measuring ESG.
Step 1: Use industry-specific frameworks like the Sustainability Accounting Standards Board (SASB) or Global Reporting Initiative (GRI) to identify the relevant metrics for your business. These metrics could include parameters like compensation for your employees, diversity on your board of directors, or greenhouse gas emissions.
Step 2: Gather data on your company's performance through sources such as financial reports, reports from suppliers, and industry benchmarks.
Step 3: Review and assess the company's trends, strengths, and weaknesses by analysing available data. It may be helpful to compare the findings with similar companies or sustainability standards such as GRI or SASB.
Step 4: Publish the ESG results on the website or share the ESG performance with relevant stakeholders.
Finally, to enhance the performance, use the gained insights to create a plan that addresses any identified weaknesses. This should involve setting ESG targets and goals, with key performance indicators (KPIs) to measure progress, while implementing new policies and practices.
ESG Measurement Tools
ESG measurement tools are used to assess the sustainability practices of a company or investment portfolio. These tools provide stakeholders, investors, and other related parties with a detailed understanding of the company's ESG performance. It's important to use these tools and evaluate the company using established metrics.
ESG Ratings: Specialised rating agencies collect data from organisations to evaluate their ethical practices and provide ratings. MSCI is a common ESG rating system, along with FTSE, ISS, Sustainalytics, and many others.
ESG Indexes: Stock indexes track companies' performance that meet certain ESG criteria.
ESG Audits: Getting audits from a third-party agency is recommended since they can assess all ESG factors transparently, helping make unbiased, better decisions.
ESG Questionnaires and Surveys: While investing, you have the option to request companies to complete a questionnaire regarding their ESG practices and strategy. The questionnaire should be thorough to help you make informed decisions.
ESG Software Platforms: Companies have various digital tools available to track and measure different ESG metrics. These tools can also help in benchmarking against industry peers, identifying areas for improvement, and creating sustainability reports and disclosures.
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ESG Performance Drawbacks To Avoid
To improve the integration of ESG factors and their values within the portfolio, firms should adopt a "zoom in, zoom out" approach. This involves focusing on the specifics, such as concentration, tracking errors, and risk, while remaining mindful of the big picture.
Firms can improve their risk frameworks regarding ESG threats and failures by both zooming in and zooming out. Zooming in helps highlight specific threats and failures while zooming out provides insight into underlying processes and bigger-picture strategies and opportunities. Neglecting either perspective can result in missed opportunities for improving performance in PE/VC investments.
Finally, it is crucial to have a reliable and consistent data source for ESG benchmarks and metrics. This will provide you with accurate and trustworthy information, as well as transparent reports for investors. Ensuring a single source of truth is important to effectively measure ESG performance.
The Bottom Line
As the world deals with challenges like climate change, social inequality, and business ethics, companies that prioritise ESG considerations in their strategies stand to thrive in the near-term simply because of a greater commitment to reporting data, and thereby identifying areas for improvement. By doing this, businesses can create long-term value for themselves and their stakeholders, while contributing towards a more sustainable and fair society, something that markets itself in terms of public visibility into company practices and brand recognition.
Yes, improving ESG performance is a complex task that involves various strategies and challenges. Change and adaptation to evolving circumstances are, however, normal benchmarks of progress in any business that seeks to evolve in a healthy, open manner. ESG metrics are crucial in this process, and a collaborative approach is necessary to ensure success.
Compare company ESG performance via ESG ratings, available at our Company ESG Profiles page.
Frequently Asked Questions (FAQs)
How is ESG performance measured?
ESG performance is commonly measured using both quantitative and qualitative indicators. These indicators may include metrics such as carbon emissions, water usage, employee turnover rates, board diversity, executive compensation, and more.
What are ESG performance indicators?
ESG performance indicators are metrics used to evaluate a company's environmental, social, and governance performance. These indicators can cover various quantitative and qualitative measures, including greenhouse gas emissions, employee turnover rates, board diversity, executive compensation, community engagement, and more.
Why is ESG performance important?
Companies and investors are placing greater importance on ESG performance. If a company has strong ESG performance, it is viewed as more responsible and sustainable. This, in turn, increases the chances of attracting more investors and customers. Investors also prefer investing in companies aligned with their values, and those that exhibit strong ESG performance, as they have a better chance of performing well over the long term.
How can I improve my ESG performance?
To enhance your ESG performance, take a comprehensive approach that takes into account how business decisions affect the environment, society, and governance. To achieve ESG objectives, it is important to set clear goals and policies. Regular ESG assessments can identify areas that require improvement. Engage with stakeholders to understand their interests and preferences. Invest in sustainable technologies and practices. Cultivate a diverse and inclusive workforce. Finally, be transparent about ESG performance and take responsibility for it.
What are the 4 pillars of ESG metrics?
The 4 pillars of ESG metrics cover different aspects of a company's impact. The environmental pillar looks at factors like carbon emissions, waste management, water usage, and energy consumption. The social pillar considers factors like labour practices, human rights, employee health and safety, community engagement, and diversity and inclusion, focusing on how a company affects its stakeholders.
The governance pillar pertains to a company's governance structure and practices, encompassing board diversity, ethical business practices, executive compensation, and shareholder rights. The financial pillar, on the other hand, relates to a company's financial performance, covering revenue growth, profit margins, and return on investment.