ESG investments, what are they

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What are ESG criteria?

ESG is the acronym for Environment, Social, and Governance, and defines precise criteria for evaluating investments. These initials relate to the way a company operates in relation to the macro-environments identified by the three letters: “E” for “environmental”, i.e., how a company conducts its business in relation to the environment; “S” for “social”, i.e., how a company treats its employees, customers, suppliers and communities it comes in contact with; and “G” for “governance”, i.e., how it sets up its management, internal control and monitoring systems, as well as compliance issues.

These criteria are developed by specialized rating companies who collect and compare documentation from public data obtained through companies, research institutes, consumer and trade associations as well as results from their own research or interviews with companies. The criteria can be positive or negative. If the companies meet the criteria positively, it means that they are actively contributing to the improvement of areas identified by the three parameters. If the companies are negative, it means that they are only committed to a stepwise reduction in the negative impact.

Environmental criteria

These are the set of parameters that measure a company's environmental impact. Some of the most important aspects taken into account by these criteria are the type of energy used; the generation or non-generation of air or water pollutants (e.g., greenhouse gas emissions or environmentally harmful liquids); waste generation and its disposal policy; land use and the exploitation of natural resources and the treatment of animals. The environmental criteria take into account the actual aspects and the potential risks of business activity and preventive measures taken by the companies.

Social criteria

This parameter measures the social impact of a company. The most important aspects that are taken into account are compliance with all forms of personal rights and the exclusion of forms of discrimination in the workplace (e.g., gender inequality); the system of internal and external relationships, that is, the treatment of employees, suppliers, customers, stakeholders and shareholders; as well as the health and hygiene conditions and the mental and physical well-being of the employees and people who interact with the company.

Governance criteria

The governance parameter measures how well company’s management adheres to sustainable corporate governance. The main criteria are: transparency in administration and access to financial statements; compliance with ethical principles, company guidelines and institutional guidelines (e.g. data processing and data protection); the absence of conflicts of interest and compliance with shareholders' interests and compliance with legal norms.

Where do the ESG criteria come from?

ESG investing is not an absolute novelty in the financial market. It was preceded by the idea of ethical investing (SRI = Socially Responsible Investment), which has been around for several decades. The ESG investment criteria are derived directly from the UN Principles for Responsible Investment (PRI) from 2006. They are the result of the work of then Secretary-General of the United Nations, Kofi Annan, and a group made up of the world's largest institutional investors. The six core principles for investing in ESG, which have subsequently been signed by thousands of financial sector players, were borne about from the UN’s work.

What can we expect in the future?

The ESG criteria for sustainable investments are constantly evolving. In 2015, the United Nations took a further step by adopting the 2030 Agenda for Sustainable Development. Specifically, the agenda consists of the so-called SDGs (Sustainable Development Goals). These are seventeen programmatic goals connected with sustainable development. These seventeen points are broken down into 169 specific goals. National governments and rating agencies are gradually refining their evaluation tools for ESG criteria by combining the SDG goals with new data science and monitoring programs.

Why invest in ESG products

There are many reasons to invest in products that meet ESG criteria. First, it is a development model that is aware of environmental risks and aims to reverse the course of climate change. This means committing to more efficient uses of energy and resources, which in the long term can be reflected in more productive forms of development. Second, ESG investments are responding to the growing sensitivity of public opinion on the topic: from the “Fridays for Future” movement to the many studies that show a growing interest among savers in sustainable financial products. Morningstar has calculated, for example, that the demand for sustainable ETFs and funds has increased tenfold in the last ten years.

Last but not least, one has to take into account the European Union’s efforts in promoting ESG investments. In 2018, the Sustainable Finance Action Plan was launched to achieve the European Green Deal and the goals set out in the 2015 Paris Agreement. The “taxonomy for sustainable finance”, which is already supported by the final report on technical regulatory standards, will be a decisive standard in being able to offer small savers a transparent and uniform framework for the ESG assessment of investments as early as 2022. The changed environmental sensitivity of the European institutions is also reflected in the extraordinary aid plan for the economy in 2020, the so-called "Recovery Fund”: 30% of the 750 billion made available by the EU are tied to investments aimed at the “energy transition”, i.e., productive activities that largely meet the ESG criteria.

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