ESG Risk Management

What ESG Means — to Investors and to Operating Companies

The term ESG refers to a kind of investing and to the conduct of operating businesses. ESG investors and companies that use ESG principles share a belief that their decisions should take account of considerations and metrics not reflected in traditional financial statements.

Investors and operating companies however often have different perspectives on ESG.

ESG investors demand that issuers of securities be responsive to ESG considerations. The historical background of ESG is “socially responsible investing” or “SRI”. Over time much of the “beyond the financials” thinking, and the terminology used, came to be called “sustainable investing” and “responsible investing”. For such investors “ESG” is now the semi-official term of choice and the relevant unifying concept.

On the other hand, beginning in the second half of the last Century, social and political reformers developed and advocated for the concept of “corporate social responsibility” or “CSR”, and the related terms “stakeholder capitalism”, “conscious capitalism” and “sustainable business” came into usage. All of these denoted “beyond the financials” values and thinking. The uptake of these concepts by the business community has moved from antagonism or cautious approval to a much broader and increasing acceptance. This has been accompanied by an almost general acceptance of the ESG concept and terminology.

ESG is different for businesses in that ESG is a sort of “soft law” — “expectations with consequences” — and businesses increasingly believe they have to satisfy those expectations or suffer adverse consequences. In short, ESG risks comprise a whole new category of risks to be managed.

Environmental, Social and Governance Factors

The main characteristic of ESG is the grouping of what we at McAlan call “factors” into three categories: environmental, social and governance. Here are some, but not all, of the factors:

In the environmental category, :

  • Climate change and carbon emissions, which may result in
    • assets becoming impaired, and
    • adverse consequences to contributors to climate change
  • Utilization of “natural capital” (such as biodiversity and raw materials sourcing)
  • Pollution and waste management
  • Energy efficiency
  • Use of green technologies and renewable energy
  • Air and water pollution
  • Deforestation
  • Water scarcity

In the social category:

  • Health, safety, and human capital development
  • Product and consumer safety
  • Community relations
  • Social opportunities
  • Customer satisfaction
  • Data protection and privacy
  • Gender and diversity
  • Employee engagement
  • Community relations
  • Human rights
  • Labor standards

And in governance:

  • Corporate governance fairness and accountability
  • Transparency and ethics
  • Board composition
  • Audit committee
  • Bribery and corruption
  • Executive compensation
  • Lobbying
  • Political contributions
  • Whistleblower schemes

We see all these as risk factors, and believe they should be managed accordingly.

We at McAlan submit that a company’s risk management is another factor in the Governance category, perhaps the most important of all