We live in an era of profound change, and in recent years the metrics by which companies are evaluated are also changing. Productivity is no longer the only variable to be considered. Stakeholders, customers, and end-consumers are increasingly attentive to the company’s sustainability, whose products/services they buy or with which they begin to collaborate. That is why there has been a need to assign value to organizations’ ability to safeguard the environment and society in which they operate through ethical and sustainable governance. Let’s find out what ESG criteria are and how they are calculated.
What are ESG criteria?
ESG is an acronym for the most relevant aspects of sustainability: Environmental, Social, and Governance. Based on these values, it is possible to define how attentive an organization is to the environment in which it operates, its ethical approach, and its green impact. This is why investors and lenders prefer careful companies that pay attention to these aspects.
Here is a first macro definition of ESG criteria:
- Environmental criteria refer to the impact business activities have on the climate and environmental resources. It is a value that indicates how waste is managed, water pollution, and the use of energy resources. Not only that, business risks related to emissions and greenhouse gases and climate change are also considered.
- Social criteria are values based on the corporate social impact generated by relationships with stakeholders, lenders, employees, and local communities. Volunteer actions, social inclusion, internal skills development, well-being generated in the community, and nurturing talent in the company are evaluated.
- Governance criteria, on the other hand, cover risk and crisis management; corporate controls and procedures, but also compliance with legal aspects; transparency of decisions; and business ethics. This value expresses the practices that the company adopts to govern itself.
The role of these indicators is to improve critical sustainable issues and show, even externally, the company’s commitment to sustainability. Actions to increase these values are oriented, in fact, toward transparency and improving reputation.
Environment: what aspects to consider
An organization’s activities, whether manufacturing or services, have a greater or lesser impact on the environment. When an organization wants to know the environmental rating related to its activities, it needs to highlight what risks might be generated by the impact. But also what issues its stakeholders might be interested in.
Corporate market trends show that 73 percent of all B2B buyers plan to deselect suppliers based on environmental performance. Those with low ESG ratings are less likely to be chosen by companies that aim to be sustainable.
- It is worthwhile, therefore, to make a list of potential issues to consider among:
water management and waste disposal;
- carbon emissions and climate change (clean air, land use, habitat, and biodiversity);
- renewable energy and products and services that take advantage of green technologies.
If one does not want to rely on outside consulting firms, an excellent way to approach the definition of ESG criteria is to look at reports compiled by competing companies. The reports will make clear which parameters appeal to investors and stakeholders in our target market. Fundamental to that criterion is predicting and managing an environmental crisis and having the ability to assess the carbon footprint of one’s processes and products.
Society: how the company ensures the welfare of the community
However, the environment is not the only external element that is passively influenced. The social context in which one operates is another aspect that distinguishes a business-oriented purely toward profit from one interested in the community’s internal and external well-being. Leadership that cares about the welfare of employees is committed to diversity management by promoting diversity inclusion and equity of treatment policies.
Activities that enhance social rating include:
- policies on a personal, employee, and consumer data security;
- innovations and responsible marketing that increase economic development;
- initiatives aimed at skills development, women’s inclusion, and employee well-being in the workplace.
But it is not only these aspects that are relevant. Social impact also concerns the activities that the company actively engages in outwardly. For example, voluntary actions but also the respect and involvement of local communities in marginal activities.
ESG criteria define how attentive an organization is to the context in which it operates, its ethical approach, and green impact. Click To Tweet
Governance: sustainability starts with strategic decisions and leaders
When a company wants to become sustainable, it does not implement targeted actions focused only on certain times but sets its entire strategy, vision, and mission toward a sustainable future. It develops plans for responsible advocacy, ensures that accounting is accurate and transparent and that actions are ethically sound.
The term Governance includes the sustainability of actions taken by board members. Organized into a single committee or assigned to specific topics, members are expected to direct departmental leaders and managers toward sustainable actions with specific strategies for ESG criteria that, in the case of Governance, affect:
- diversity and inclusion (DEI) issues;
- the company’s ethical approaches and compliance with the guidelines of national or international bodies;
- internal Governance and ESG-oriented corporate management.
To successfully embark on a sustainable path, which end customers also recognize, it is essential that all sustainability issues play an important role in monthly meetings. There is no need to design a strategy and check only what has been achieved at the end of the year. A task force must be dedicated to sustainability, especially in the early stages, aligning all managers on specific survey tasks to make a difference. Only then will the path be more efficient and productive.
How ESG criteria are calculated
A quick look at the topics related to ESG criteria allows us to understand their importance for companies but also the complexity of defining the rating, i.e., the score to be assigned to companies. This is because giving an exact value to aspects that are not always quantifiable is not easy.
Moreover, even certifying agencies have different rating criteria, as there is currently no single universal reference standard. The most widely used scale is from 0 to 100, where:
- 0 to 25: poor relative ESG performance;
- 25 to 50: satisfactory ESG performance;
- 50 to 75: good ESG performance;
- 75 to 100 excellent ESG performance.
Thus, when an external consultant subjects the company to an assessment, they choose not only the scale of reference but also what aspects to consider and focus on for that type of organization.
The aspects to be evaluated and measured could include:
- the degree to which the organization is aligned with sustainable guidelines provided by international bodies such as the EU, UN, and OECD;
- how much ESG factors affect corporate economic value;
- the quantification of the risks and opportunities of a proper ESG criteria rating plan compared to even competitors already committed to issues related to climate change, resource scarcity, or the social impact of their actions.
Aiming for a high ESG rating means choosing investors and suppliers with whom to partner; increasing the likelihood of obtaining substantial funds and financing from banks; and having a strong appeal to customers and end consumers by securing an advantage over competitors. Today, showing attention to sustainability is also, and above all, a moral duty to ensure a human-friendly world.