What is ESG?
ESG stands for Environment, Social, and Governance. ESG as a whole appeared in the “Who Cares Wins” report released by the United Nations Global Compact in 2004. The report was written with the participation of 20 financial institutions and aimed to encourage participants and stakeholders in the financial industry to incorporate environmental, social, and governance factors into their business scope.
What stakeholders are involved in ESG? In the “Who Cares Wins” report, companies, regulatory agencies, accountants, exchanges, and asset managers are all included. Financial institutions provide services to companies, and when financial institutions begin to consider ESG, companies also need to incorporate it into their business activities. The disclosure of ESG information by companies is closely related to stakeholders such as regulatory agencies, accountants, and exchanges.
Related Post: Origin of ESG: Global Compact “Who Cares Wins”
Why is ESG Important?
Before ESG was proposed as a whole, the environmental, social, and governance aspects had already gained widespread recognition. The concept of sustainable development was proposed in the 1987 United Nations publication ‘Our Common Future’, which aims to meet contemporary needs without harming the interests of future generations. Environmental, social, and economic factors have become the core components of sustainable development. At the governance level, the market has also recognized the importance of good governance for corporate financial performance, and the correlation between governance and corporate financial performance and stock price performance is usually stronger than environmental and social factors.
In addition to the positive impact of ESG on society as a whole, ESG is also an important factor that cannot be ignored for the stakeholders mentioned earlier. As the proposer of ESG concepts, the financial industry hopes to provide long-term services to enterprises, and the good performance of enterprises in the fields of environment, society, and governance can reduce their operational risks. Exchanges and regulatory agencies are responsible for corporate information disclosure. As the market gradually recognizes the impact of corporate behavior on the environment and society, regulatory authorities are also developing disclosure rules that require companies to consider double materiality. Double materiality includes financial materiality and impact materiality, the latter of which refers to the impact of a company on the environment and society.
Current Development of ESG
From a long-term perspective, ESG and climate change, carbon emissions, nature, biodiversity, and other topics are receiving increasing attention. Climate has become the primary concern for many ESG issues, as reflected in the global disclosure standards developed by the International Sustainability Standards Board. IFRS S1 serves as a general guideline for corporate information disclosure, while IFRS S2 is the standard for climate related information disclosure. Climate change and its associated carbon emissions and natural factors have progressed in ESG.
Formulating corporate information disclosure standards is an important action taken by regulatory agencies in the development of ESG. Correspondingly, companies need to engage in ESG compliant business activities and complete information disclosure in accordance with regulations. As the initiator of ESG concepts, the financial industry can provide green financial services to enterprises, including ESG bonds, sustainable loans, and more. The financial industry, as a bridge connecting investors and companies, can also raise funds from investors through ESG funds to invest in bonds or stocks issued by companies. The fastest progress in this field is the European Sustainable Finance Disclosure Regulation, which includes Article 9 funds with sustainable goals and Article 8 funds with sustainable features.
Difficulties Faced by ESG
Although ESG has gained attention from market participants, it faces a series of difficulties in its actual development. The long-term nature of ESG means that companies need to bear short-term and medium-term investment costs in order to meet the requirements of investors and regulatory agencies. There is currently no consistent global standard for corporate information disclosure, which requires multinational corporations to bear additional compliance costs when writing ESG reports, and investors in different jurisdictions also face certain difficulties in the availability of corporate information disclosure.
Besides cost issues, greenwashing has also become a hot topic accompanying the development of ESG. Greenwashing may exist in enterprises, investors, and asset management companies, and its scope is almost linked to the activities of all ESG stakeholders. Dealing with greenwashing is a core topic for regulatory agencies in formulating ESG policies. Corporate information disclosure, measurement of the green impact of corporate products and services, naming and investment ratios of ESG funds are all directions for the gradual improvement of regulatory policies.
Future Development of ESG
Environmental factors are the most concerned ESG factors before achieving net zero globally by 2050. Economic activities centered around environmental factors, such as reducing carbon emissions, investing in clean energy, and developing transformation plans, involve numerous market participants. Whether it is technological innovation or ESG investment, the environment is the most important development direction. Compared to other factors, social factors have made slower progress in measuring standards, their externalities are weaker than environmental factors, and their attention is also weaker than environmental factors.
Governance is the essential factor in ESG history. If environmental and social factors can be regarded as the core elements of ESG information disclosure, governance is the core element when the rules for corporate financial information disclosure are released. The importance of governance in ESG lies in the fact that all decision-making activities related to the environment and society require the support of the company’s board of directors, management, and governance system. Therefore, governance is the key to financial substance and the key to influencing substance.
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