What are ESG issues?

ESG is an acronym for environment, social, and governance and is a framework used to measure the value of a business based on its impact on those three factors. The environmental criteria assess the effects of or interaction with the environment, including impacts on biodiversity, supply chain sustainability, environmental resources, and climate change.  

ESG and Social Criteria

The social criteria assess the social impact on consumers, employees, suppliers, contractors, and the local and broader community. This factor focuses on human rights and diversity adherence, data privacy compliance, political and investment spending, and product safety concerns. The governance component considers the self-governance and internal management practices of a business. It measures how responsibly the company has managed its finances and its duty to its shareholders and stakeholders.  

Why is ESG so important for companies?

Increasingly, stakeholders and investors require more transparency surrounding the business practices that affect ESG. Businesses that commit to supporting and contributing to the environmental and social health of their local and broader communities are becoming more appealing to investors and consumers and are attracting greater investment and consumer spending. Investing in a strong ESG strategy can potentially:

• increase consumer connection,
• strengthen business partner relationships,
• prevent regulatory compliance issues,
• attract employees who share in the values of the business,
• increase cost savings,
• and promote risk management.  

Increase Consumer Connection

One of the most important ESG considerations for consumer-facing businesses is the ability to attract and connect with its consumers. The main revenue point for most consumer-facing businesses is consumer spending, so connecting with your consumers is extremely important. Consumers are starting to base their purchase decisions on these factors and choosing to purchase from businesses that care about how their business impacts the ESG issues they face. Polls show that more than three out of five consumers consider ESG factors before making a purchase decision – 68% consider the environmental responsibility of the business, 71% consider the social responsibility, and 51% consider the governance practices.  

Therefore, more than half of your consumers are paying attention to your business's position on ESG issues. If your business fails to prioritize its environmental and social impact, consumer dissatisfaction and declining customer patronage can affect the company's overall financial health.   

Strengthen Business Partner Relationships

ESG considerations are not only important for consumer-facing businesses. Businesses that have already built strong connections with their customer base are looking to partner with other companies that share the same values. As previously noted, consumers are not only paying attention to the businesses that they choose to patronize but also to the partnerships and alliances that those businesses make. Responsible ESG practices make your business a stronger candidate for partnerships with other like-minded businesses. 

The Competitive Advantage of Caring About ESG Issues

Additionally, businesses that care about ESG have a competitive advantage as customers, investors, and other stakeholders are increasingly looking for socially responsible and environmentally sustainable companies. One study shows that 89% of investors consider ESG issues when making investment decisions. That means approximately 9 out of 10 investors evaluate these factors when considering partnerships. The opportunity cost of not caring about ESG issues is steep and can affect your current and future collaborations.

ESG Issues and Regulatory Compliance

The Financial Stability Board (“FSB”), an international entity that monitors the global financial system and makes recommendations based on its findings, created the Task Force on Climate-Related Financial Disclosures (“TFCD”). The TFCD was designed to make recommendations on what information should be disclosed to assist investors, lenders, and insurance underwriters in making risk assessment decisions regarding climate change. Based on these recommendations, international governments are imposing regulations on businesses to address ESG issues. Recently, the European Union ("E.U.") has created directives requiring companies to report how their operation affects the environmental and social ecosystems they serve or interact with.  These directives affect not only EU-based businesses but could also affect businesses that interact with E.U. markets (including U.S.-based companies).  

United States ESG Regulations

While not as strong as E.U. regulations, U.S. Regulations are also becoming more stringent.   The Securities and Exchange Commission (“SEC”) has revised Regulation S-K requiring new descriptions for a company's “human capital resources” and any measures the company uses to develop, attract, and retain employees. The SEC has also approved a change in the NASDAQ rules requiring companies to either:

(1) have at least two diverse directors on their boards; or

(2) explain why they do not have at least two diverse directors on their boards.  

President Biden issued an executive order requiring the federal government to direct the initiative, strongly suggesting financial regulators focus on disclosing, assessing, and mitigating climate-related risks. The Financial Stability Oversight Council was created to implement this executive order, and additional regulations will likely soon follow.   

Similarly, several state legislatures are working on legislation and regulations promoting responsible ESG practices. Many of these regulations currently focus on government spending and fiscal responsibility regarding state pension and retirement investing, but this is likely only the beginning. It is prudent to expand your ESG agenda to include the most sustainable practices to prevent regulatory issues in the near future.

Attract Employees that Share Your Values

Potential employees are also consumers and are taking notice of the ESG framework of the companies they work for. Four out of five current employees (83%) report that they do not believe their employer is doing enough, and 71% state that they want to work for environmentally-friendly employers. Environmental and social justice concerns are rising, and employees do not want to be responsible for contributing to negative impacts on the environment or other people. There is also an assumption that if a company cares about its ESG framework and its overall reputation, it will be more likely to be a comfortable and enjoyable workplace. 

After the recent Great Resignation, employees have been more mindful of where and how they are willing to work and are rethinking what role “work” will play in their lives. In this reassessment, employees are seeking out employers whose values align with their own. Businesses promoting strong ESG values will likely have the best options for recruiting top talent.

Increase Cost Savings

There is a popular belief that being environmentally friendly is expensive or has high initial investment costs, but that is not necessarily the case. Adopting sustainable practices can reduce energy consumption, carbon emissions, and waste generation in a business. This reduction in energy consumption can lead to substantial cost savings over time. Businesses prioritizing ESG are more likely to have a long-term perspective which may help them weather economic downturns and market fluctuations.  Also, understanding and implementing socially acceptable employment policies costs a business only the time it takes to research these policies. These employment policies are required for legal compliance, so that implementation will save additional money in legal fees and court costs. Furthermore, transparent corporate governance and legal compliance will also prevent unnecessary and unexpected lawsuits.

Promote Risk Management

Prioritizing ESG can help businesses manage risks because expensive lawsuits arising from hazardous or strenuous employment conditions leading to employee harm, injury caused by environmental damage to communities or individuals, or damages caused by financial impropriety can result if ESG factors are ignored. In addition to legal risks, potential reputational harm can result if consumers or investors learn that your business has failed to value these factors. Finally, failure to adopt sustainable practices could lead to economic harm if resources diminish or are eliminated.   

Good ESG practices

Specific best ESG practices may vary by industry, and a financial risk manager or attorney may be a good resource to consult to develop your particular strategy.   However, here are some ways that companies can expand their ESG agenda to be more investor and consumer-friendly.   

Environmental Considerations

Consider the environment and how your business decisions affect the local ecosystem. Consider every living thing, including plants, humans, insects, and animals. Ensure that your strategy fully integrates ethical and environmentally responsible practices. Try to make sure that you are sourcing from sustainable partners. Focus on a specific environmental area that can be improved, like reducing your carbon emissions or using renewable energy instead of fossil fuels. Implement changes that reduce your impact to net-zero targets.

Social Considerations

Consider how your business operation affects the social structure of the communities you serve. Examine your hiring practices and ensure they are racially and gender-diverse. Also, consider your workplace environment and ensure all employees are treated well and compensated fairly.  If applicable, audit your business facility to ensure that the workplace is safe for employees, suppliers, contractors, and consumers.   Demo your products often to ensure that any products you produce are safe. Ensure that your business complies with cybersecurity best practices and has an incident response protocol in place. Research the companies your business invests in or partners with and ensure that those companies follow responsible ESG practices. If your business invests in political candidates or campaigns, ensure a thorough understanding of the platforms of those political campaigns and confirm that the ESG strategies of those politicians or political campaigns align with your own. 

Consider participation in charity work and volunteer projects if the business is not already participating in these activities. If you are already participating in charity work and volunteer projects, consider expanding those efforts to partner with even more charities or programs that positively impact the local ecosystem. 

Governance Considerations

Consider how your business governs itself. Allow transparency in the financial records of your business, including transparency in the executives' salaries. Make sure that shareholder dividends are fairly distributed and proportionate to business earnings. Ensure that the Board of Directors is independent of the company's management team. You want to ensure that the Board members are free to make decisions regarding company management without concerns about job loss or reprimand.

Conclusion

In conclusion, as financial and consumer markets are placing more emphasis on the ESG agenda of businesses they partner with, businesses should consider becoming more environmentally and socially responsible for increasing marketability.Additionally, as regulations increase worldwide, it will be necessary for businesses to understand and comply with those regulations to prevent penalties or exclusion.

Questions about ESG issues and how to implement ESG policies into your business? Contact our experienced legal team today for a free consultation.