Overview of ESG and materiality assessments

Around the world, asset managers and retail/institutional wealth managers are increasing their standards for publicly-listed companies. According to Larry Fink, CEO of BlackRock, the world’s largest asset manager, “climate change has become a defining factor in companies’ long-term prospects…[and] we are on the edge of a fundamental reshaping of finance.” As of 2019, approximately 75% percent of institutional investors were applying environmental, social and governance (ESG) principles to at least a quarter of their portfolios. Due to this, it is important to consider how your company is performing in terms of ESG factors, particularly if you are a publicly traded company or thinking of becoming one.

Fundamentals and history of ESG

ESG is an investment strategy that focuses on financial returns while promoting social and environmental good. There are specific criteria and considerations associated with each letter:

E – Environment (how a company reduces and manages emissions, waste, etc.)

S – Social (how a company treats people including employee relations, human rights, customer privacy, etc.)

G – Governance (how a company creates and enforces policies around board diversity, executive compensation, corruption, etc.)

Over the last few decades, ESG investing has grown rapidly in response to consumer concerns around topics like carbon emissions, waste, human rights, board diversity and executive compensation. In part, ESG arose due to drawbacks associated with socially responsible investing (SRI) and impact investing. SRI is where investors choose not to invest in companies due to ethical concerns over practices (e.g. production of weapons, environmental damage, etc.) while impact investing involves investing with the intention of achieving a specific social or environmental goal.

While SRI allows investors to take a strong moral stance, it can take a narrow approach and exclude industry sectors which limits financial returns. Thus, ESG has grown in popularity as it supports environmental and social ideals without excluding sectors and sacrificing returns.

Why ESG is relevant and how ratings can impact your company

More and more investors, particularly among younger generations, are using ESG ratings and indices to evaluate company performance and inform investment decisions. While not being as negative as SRI, ESG can negatively impact a company’s brand and reputation, both among consumers and shareholders.

What can be confusing for retailers is that there are multiple ESG indices that factor in different criteria when evaluating companies. For example:

Companies voluntarily choose to submit data and it can be time consuming to fill-out surveys so it is important to find longstanding and respected surveys. S&P Global recently acquired the SAM* Corporate Sustainability Assessment (CSA), which is recognized as one of the most advanced ESG scoring methodologies as it has been around for over 20 years and evaluates corporate sustainability practices. Through a series of customized questionnaires on the most relevant ESG issues, CSA evaluates thousands of companies from various sectors on an annual basis.

Common criteria include: human rights, climate strategy, tax transparency, policy influence, customer relationship management, local impact of business operations, raw material sourcing, environmental reporting, and many more.

Based on this data, indices are created which involves excluding low-scoring companies when compared to peers or other exclusionary criteria (e.g. sale of controversial weapons). Following this, the remaining companies are sorted and selected based on scores followed by additional weighting factors. The top companies will then make up an index and investors can choose whether to invest in it.

Materiality Assessments – Identifying the most relevant ESG issues for your company

You can conduct materiality assessments to determine which ESG issues are relevant and important to your company. This starts with identifying stakeholders, both internally and externally, who can provide feedback on a range of economic, environmental and social indicators via surveys. Information can then be analyzed to identify what areas are most important to stakeholders. Although this process can take time and resources, it can be an important part of developing sustainability strategies that in turn will help improve ESG ratings. Analyses can also lead to improved efficiencies which can have positive financial impacts.

The Sustainability Accounting Standards Board (SASB) is a popular resource to help “identify, manage and report on the sustainability topics that matter most to investors” while choosing priorities that align with company values.

Things to consider:

Consider value chain partners – who are your biggest suppliers and consumers?
Look at news sources and social media platforms to determine consumer sentiments
Index providers have excellent repositories on ESG scoring, both domestically and globally
If you have access to the Bloomberg Investment Terminal, check to see how your company is performing –
- It has many features including the ability to map supply chains overlaid with population heatmaps and geopolitical risks

Post COVID-19 opportunities

Although many retailers have been negatively impacted by the COVID-19 pandemic, it can also offer opportunities to responsibly rebuild and take a holistic approach to ESG rather than working in silos. For example, there may be opportunities to optimize supply chains and look for new ways to source responsibly while resetting expense and operating models. Data can also be a powerful tool to identify operational inefficiencies and new business opportunities.