Below is an introductory video about the ESG framework, in which STaR project assistant Rohan talks to Wolfgang Rattay, the CEO of Values and Guidance, an investment firm focused on making sustainable long term investments for their clients. The interview touches upon the current challenges in the ESG industry and the changes Mr. Rattay   hopes to see in the future.

What is ESG?

ESG stands for Environmental, Social, and Governance standards. It is a framework that companies use to evaluate their sustainability. It originated in the finance industry, from investment philosophies that were focused on sustainability and socially responsible investing. These criteria measure how well companies look after the environment and the communities where they operate, as well as how robust their management and corporate governance policies are.

Why is ESG Important?

In today's world of heightened social awareness, consumers and other stakeholders are pushing businesses to recognize and report their impact on environmental and social issues in addition to their traditional financial reporting. There is also growing evidence that the financial performance of companies correlates to how well they deal with ESG matters.

Is ESG and CSR the same thing?

They are related as they fall under the umbrella of sustainability and share the common goal of promoting responsible business practices, but they are not the same thing.

Corporate Social Responsibility (CSR) revolves around the concept that businesses bear an obligation to contribute to the well-being of the society in which they operate rather than focusing solely on economic gains and profit margins. It was first described as such in Howard Bowen’s 1953 book Social Responsibilities of the Businessman. Today CSR involves activities such as donations, volunteer work, commitment to reducing carbon footprint, and more. One well know example of CSR pioneers among company founders is Yvon Chouinard of apparel company Patagonia, pledging all of its future profits to an organization that fights the climate crisis.

ESG, on the other hand, is a framework to evaluate the sustainability efforts of the company using environmental, social, and governance metrics. The term ESG became mainstream in early 2000’s, although the practice can be traced back to earlier decades. ESG is data driven. In many companies, ESG policies are guided by frameworks established by external organizations, enabling the assessment of projects/investments through ESG scores and ratings for comparative analysis.

In brief, CSR can be viewed both as a forerunner and parallel to ESG. The endeavors initiated within a CSR strategy can be fine-tuned and aligned with ESG metrics.

What does ESG measure?

The E measures the impact a company has on the environment. This may include but is not limited to the company's carbon footprint, its water and land usage, and other environmental sustainability measures.

The S measures how a company contributes to the community it operates in, and whether it engages in philanthropy beyond the scope of its business. It also evaluates hiring practices, inclusiveness, and other similar factors.

The G measures how robust a company's frameworks are for dealing with anti-competitive practices and corruption. It also measures how executives are compensated, as well as their interactions with all concerned stakeholders.

It is important to note that companies mostly report on issues they consider material to them.

What do you mean by material issues?

Material issues or materiality in the ESG context refers to any issue that can have an impact on the financial performance of a company. What is material to a company depends on the industry it is in, which countries it operates in, and other relevant aspects. To learn more, we recommend the following article.

Are only financially material issues considered?

It used to be that only financially material issues were considered but recently, double materiality has started to gain traction. Double materiality means that financially material issues as well as socially material issues are treated as material.

How do companies report on their ESG activities?

As of now, there is no global consensus of reporting on ESG activities. Companies can choose from a wide array of frameworks that best match their needs. Some of the most common frameworks are International Integrated Reporting Council framework (IIRC), the Global Reporting Initiative (GRI), Principles of Responsible Investing (PRI), the Task Force on Climate-related Financial Disclosures (TCFD), Sustainability Accounting Standards Board (SASB) framework, and the UN Global Compact.

For more information about the different types of reporting frameworks, check our resource libraries section

Is ESG reporting mandatory?

As of now, it is not mandatory for companies to report on their ESG activities but that is about to change. The EU has passed the Corporate Sustainability Reporting Directive (CSRD). It came into effect in January 2023. Starting FY 2024, most companies operating in the EU will have to report on their ESG activities.

What is an ESG score/rating?

ESG ratings are tools that help investors to assess the company's performance on non-financial matters.

Who calculates the ESG scores/ratings?

The ESG scores are calculated by the ESG ratings agencies. These scores provide a useful metric for comparing different investments. MSCI, Refinitiv, Sustainalytics and Bloomberg are some of the biggest players in this industry. Similar to credit ratings agencies that provide a score for the companies on their financial performance, ESG ratings agencies provide a score for the companies’ non-financial performance.

How is an ESG score/rating calculated?

The ratings agencies collect information from the company disclosures (annual reports, ESG disclosures), data from government sources (central banks, stock exchange disclosures), news media from local and global sources, some agencies send out questionnaires for companies to fill out. They analyze this data in detail, using their proprietary methodology and then assign a score to each company. The scores are usually on a 0-100 scale, but some companies use letter ratings (AAA-CCC or A+ to D-). See our resource libraries for more detail.

What is the ESG score/rating used for?

ESG ratings are used by institutional investors to construct sustainable portfolios and attract investments from retail investors. Companies also use ESG ratings to highlight and validate the claims of their positive impact.

Are all ESG ratings the same?

Unfortunatley they are not. This is because the ratings agencies all use their own methodologies to evaluate a company's ESG performance and since there is no standardized framework for ESG evaluation as of yet, the agencies all have differing views on what categories are the most important in ESG evaluation.

Compiled by Rohan Simon