How to Use ESG to De-risk Your Business Model
Author: Carol Tarr — Portfolio Manager
ESG stands for Environmental, Social and Governance and together form the three standards companies are scored on by the various ratings agencies. Although there are numerous ESG ratings agencies and their methodologies vary, the scores are supposed to reflect the strategy and readiness of a company to tackle issues particular to the kind of business they are in. Although ratings are currently more about avoiding adverse or negative impacts, you can be proactive in your approach to people and planet with the effect of de-risking your business model from potential regulatory problems, fines and litigation. When it comes to investment in your business, poor ESG performance and ratings may lead to an “avoid” label altogether, where you will become considered too risky because of potential losses or litigation; or be considered unaligned with investor values.
Environmental standards relate to effects the business creates on the world, such as carbon emissions, waste, toxins and water pollution. Further, what are the chances that rising water levels and climate change will affect your ability to conduct business as usual? Moreover, changing regulatory standards may lead to you having to abandon your business or part of your assets altogether — leading to what is termed “stranded assets”.
Social standards relate to the effects your business may have on communities, health, mental well-being and perpetuation or alleviation of inequalities.
Governance involves internal issues of how the company is run, such as salaries, executive compensation, employee policies, boardroom gender balance, ethical behavior… and any resulting scandals or negative press.
In my experience, while most people understand the “E” and the “S” of ESG, it is the “G” of governance that causes the most uncertainty. Many ratings agencies scan years of newspapers and other media to find any hint of scandal or previous poor behavior. Why? Because potential investors want to know what potential legal issues or other headaches may be headed their way.
In fact it’s like this for the “E” of Environmental and “S” of Social as well. As one maxim goes: the greatest indicator of future behavior is past behavior. While this is not the case for predicting stock prices or crypto currency bull runs, it sums up well what we generally believe about character and trust leading to the subjective determination of if someone and their business are investment-worthy or not.
So how can you apply ESG to your own business model? This is a comprehensive process but you can start early by paying attention to the “S” of Social in ways like hiring and making sure diversity is present from the start. For the “E” of Environmental, think of what your products are made from and where they end up when no longer needed. Are you creating additional plastic garbage for the beach/street or is the neighborhood, air and water better for you having been there?
And for the “G”, pay attention to being honest, transparent and truthful with how you conduct your business. Be empathic towards the needs of your employees, appreciate your customers and be honest with your investors. Have clear guidelines in place for items like parental leave and harassment policies. Pay people fairly, respond to complaints and don’t be sneaky to try to get around obligations. Above all, avoid any practice that you wouldn’t want to read about in the morning headlines.
A formal ESG policy can be an asset to your business and your developing reputation, not only with investors but for customers and future employees as well. De-risk your business from future harm with proactive ESG policies early.
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