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ESG criteria: challenges and implementation

Written by Piguet Galland | Jun 5, 2024 2:25:00 PM

On World Environment Day, it's important to reconsider our collective impact on the planet and the ways to reduce it. Environmental, social and governance (ESG) criteria are now key indicators for assessing corporate responsibility and sustainability.

 

What is ESG?

Since its emergence from about the year 2000, sustainable investment has been booming, to the point where it now exceeds CHF 1,600 billion in assets under management in Switzerland. This trend continues unabated, and is a real challenge for financial institutions and investors seeking to optimise financial performance whilst taking into account social and environmental responsibility. The trend is based on ESG criteria which, although non-financial, make it possible to select assets on the basis of their positive impact on the planet and on society, while seeking an attractive return and a reduction in risk. Here's a closer look at this essential portfolio management tool.

 

ESG: origin, meaning and objectives

The term ESG was coined in 2004 by Kofi Annan, then Secretary-General of the United Nations.

The acronym ESG stands for Environmental, Social and Governance criteria, used to assess the non-financial performance and social responsibility of a company, a sector or an investment.

These criteria are used to measure the direct or indirect impact of economic activity on the environment, stakeholders and the quality of governance, as follows:

  • Environmental criteria: relate to the management of natural resources, the reduction of greenhouse gas emissions, the prevention of environmental risks, waste recycling and the protection of biodiversity.
  • Social criteria: cover respect for human rights, international labour standards, the health and safety of employees, clients and suppliers, as well as social dialogue and contribution to local development.
  • Governance criteria include the transparency and ethics of management and the Board of Directors, executive remuneration, shareholder rights, Board independence, the fight against corruption, they also favour stakeholder engagement.

 

ESG criteria across time, culture and business sectors

First of all, it should be remembered that ESG evaluation is not an exact science, and that there are different methodologies and sources of information for realising this analysis. To date, there is no universal standard or consensus concerning which indicators should be assessed. This explains why ESG scores can vary from one rating agency or data provider to another.

Furthermore, ESG evaluation depends on the company's sector of activity. Environmental, social and governance issues are not the same for an oil company, a bank or a technology company. For example, greenhouse gas emissions, water consumption and waste management are more important for the energy sector than for the financial sector. Conversely, the protection of personal data, diversity and the fight against corruption are more relevant to the services sector.

This is why there are sector-specific benchmarks that allow ESG criteria to be adapted to the specific characteristics of each sector. These include the standards of the Sustainability Accounting Standards Board (SASB), which identify the most material ESG factors for 77 different sectors.

Finally, it should be noted that ESG assessment evolves over time and by region of the world. The expectations of stakeholders (clientsclients, employees, shareholders, regulators, etc.) and the regulations governing sustainable development and finance are not the same everywhere, nor are they constant. ESG assessment is therefore a dynamic and complex process. It is therefore important for investors and companies to have a good understanding of the criteria and sources of information underlying the ESG scores they use or receive.

 

What are ESG risks and how can they be avoided?

One of the reasons why sustainable finance is so popular with investors is its potential to reduce risk. Investing in companies that respect these criteria, or are in the process of doing so, often makes it possible to avoid issues that have a negative impact on their share price. How does this work out for each of the 3 pillars of ESG individually?

  • Environmental risks: encompass the potential or proven negative impacts of a company on the natural environment, such as climate change, pollution, biodiversity, waste management or the use of natural resources.
  • Social risks: concern the potential or actual negative impacts of a company on internal or external stakeholders, such as human rights, health and safety, working conditions, diversity, inclusion or the protection of personal data.
  • Governance risks: relate to the way in which a company is managed and controlled, particularly in terms of board structure, executive remuneration, the fight against corruption, compliance with legal and ethical standards, and the transparency of financial and non-financial information.

ESG risks, when poorly managed, can have a significant impact on a company's reputation, finances and long-term viability. These risks expose the company to negative consequences, such as legal action, financial penalties or reputational damage among customers, employees and investors. If these automatically impact performance (sometimes over several years), they can seriously compromise the company's attractiveness in the marketplace.

Conversely, good ESG risk management can offer a company competitive advantages, such as improved operational performance, innovation, retention of talent or access to new market opportunities.

To meet investors' expectations, companies must therefore:

  • Assess their environmental performance using relevant, internationally recognised indicators.
  • Ensure that they assess and manage social risks, by adopting responsible policies and practices, engaging in dialogue with relevant stakeholders, and reporting on their actions and results.
  • Ensuring that governance risks are properly assessed.

 

At Piguet Galland, we understand how important it is for our clients to invest in thematic funds that meet ESG criteria. Like you, we share this desire to make a difference and are convinced that sustainable and responsible finance makes a positive contribution. That's why we have set up a range of sustainable investments for our clients. We offer thematic certificates with ESG components, such as the Helv-Ethic, Climate Action and Women Empowerment certificates.

 

A responsible and sustainable management approach