ESG: What is it? How important is it in companies?
Why are companies increasingly concerned with environmental, social, and governance issues? Know more about ESG and learn some practical examples.
Have you ever heard about ESG? This concept is not something new, but it was only in 2003 that these ideas began to be disseminated among companies. In English, the acronym stands for Environmental, Social, and Governance which in free translation would be Environmental, Social, and Governance. These three metrics are used by financial resource managers to make investment decisions.
The ESG summarizes the conduct criteria of organizations in areas that are increasingly important to society: environmental, social, and governance. If before this topic was restricted to a small part of the population, today, big capital companies are considering these factors before making investments.
What is the purpose of ESG?
In the 2000s, large institutions began to realize that it was not enough to constantly seek out profits, if, on the other hand, there were losses, such as environmental accidents and global warming.
However, in 2003, the largest pension fund managers in the world, Aberdeen and Fidelity, met and signed a protocol with several principles. The “principles for responsible investment” or “principles of responsible investment”, an agreement in which these companies voluntarily commit to creating an association under UN contribution to create ESG analysis metrics.
In this case, each company is committed towards an attempt in implementing environmental, social, and governance metrics in its investments. These actions have been shown to be efficient, especially since the 2008/2009 crisis when by performing this type of analysis, asset managers were able to avoid a major loss risk on their portfolios.
Over time, a good risk-return ratio is established, which is the goal of every manager: maximizing returns and minimizing risk.
What are the ESG metrics?
For a better understanding, check out what each acronym means in practice.
The E is for the Environmental aspect, which is the company’s analysis in order to mitigate its impacts on the environment. But, why is this so important?
By analyzing the environmental risks of a company, managers are able to avoid or reduce fines and environmental accidents that lead to enormous costs. An oil company, for example, must have insurance for oil spills; a mining company must think about sustainable actions after opening holes for exploration, in the middle of the forest.
A well-known example is that of British Petroleum, BP, which happened in 2010 and caused one of the largest oil spills in history when a pipe burst at the bottom of the Gulf of Mexico. In addition to serious damage to the region’s population, there are still very serious environmental impacts on the local fauna and flora.
As you might imagine, the company paid billions of dollars in fines. In this scenario, a British Petroleum investor had, indirectly, a huge loss, due to the fact that the organization was not concerned with analyzing and reducing environmental risks properly in order to avoid the accident.
Another point of the environmental issue is the companies’ inventory referring to CO2 or CO2 equivalent emissions, which are greenhouse gases.
When assessing this inventory, investors are able to monitor whether the numbers are increasing or decreasing. A necessity, since the whole world is already regulating itself. Currently, 70% of the global GDP is already regulated, that is, it is a matter of time before countries like Brazil, which do not yet have regulations, have to comply with these rules.
The S brings the social point of view. A great example would be fast-fashion or footwear brands. Over the years, several news stories have emerged about famous brands that had unregulated activities in Southeast Asia. These companies outsourced the labor of local residents, with work comparable to slavery, even paying a dollar for 18 hours of labor.
In addition to having a huge social cost to the region, delaying development, and fomenting poverty, there is also a reputation cost for companies, since people do not want to support brands that exploit people. So, from an investment point of view, there is financial damage due to damage to the brand image, as well as local fines. Then, the ESG analyst must calculate environmental risks, social risks, and, finally, governance.
The G addresses governance risk. These risks are related to the treatment of the minority investor. It involves aspects that concern all stakeholders or participants in the company. In this case, the issues of the rights of the controllers in relation to the rights of shareholders or investors, and minority creditors come into play.
If the controller is benefiting at the expense of its minority shareholders, something is wrong. For example, two Brazilian companies, one in the steel industry and the other in paper and cellulose, in the past, charged company royalties for the use of its name. But this is an illegal practice, minority partners cannot be forced to pay for the use of the company’s name.
In addition, there are cases of organizations that place personal expenses as if they were the companies, without investor disclosure. It does not make any sense that minority shareholders pay for the private expenses of controllers. All these actions should be verified by the analyst when evaluating the governance of a company.
How important is ESG in companies?
We can say that ESG deals with several factors, each of which is more closely related to one of its definitions. Currently, clearly realizing that the management composition of Brazilian companies is formed mostly by men, whites, and those aged over 60. ESG must also promote rights and equality. The need for more women, gays, blacks, and people with disabilities among the decision-makers, stakeholders, employees, and customers of a company.
When ESG is not performed, huge losses are incurred. We can mention two examples, that of Sadia and Aracruz. At the time there was no transparency in their contracts, and investors were not able to acquire information for their decision making, companies lowered their financial cost by taking positions in foreign exchange derivatives that assumed that the dollar would always depreciate against the real.
In 2008, the dollar went from R$ 1.70 to R$ 2.60 and these companies took on huge losses. In an attempt to reverse the scenario, mergers were needed. If ESG investors had access to the balance sheets, they could carry out risk management profile analysis and prevent companies from bankruptcy.
Another example of the importance of ESG analysis is the case of Vale, a brazilian private company. After the Mariana disaster, many investors shy away from the mining sector because they believe the company hasn’t done enough to mitigate risk. Therefore, the ESG analysis does not only evaluate the profit, but also the risks involved.
What does ESG have to do with carbon credit and Moss?
All of these pillars are equally important, however, we can say that the environmental pillar is the least widespread. This is because it is harder to measure and there is still no such awareness in Brazil and many other countries.
People have not yet understood or are unaware of the importance of offsetting carbon credit, of the need for organizations to reduce the number of greenhouse gas emissions, and, consequently, do not demand it from companies.
The issue of CO2 emissions and global warming is one of the most important environmental agendas, as it is necessary to create effective actions at this moment to combat climate change.
Moss has a fundamental role in promoting ESG and supporting investors in their metrics and analysis. We assist in the assessment of smaller companies and individuals who are calculating their carbon footprint, and we are democratizing and minimizing the transaction cost for purchasing and offsetting carbon credit.
When organizations realize the strategic value in guidance and analysis of their actions based on ESG’s premises, they are now starting to worry about compensation, because in the near future, certainly, the cost will be much higher than it is today.
Moss has this solution, mainly, to develop the environmental pillar in a robust and accessible manner, since in Latin America and Brazil, actions such as these aren’t well known.
Moss’s job is to mitigate the environmental impact by developing a carbon credit trading platform. Consequently making it easier and easier to reduce transaction costs and bring the carbon emission compensation agenda into Brazilian’s daily life and, especially, companies.