ESG is a term formed from the initial letters of the concepts Environmental, Social, and Governance. ESG is a framework used to measure and evaluate companies’ sustainability performance.
- Environmental factors assess a company’s impact on the environment. These factors include energy and water efficiency, carbon emissions, waste management, use of natural resources, and environmental pollution. Companies should take various measures to reduce their environmental impact, transition to sustainable resource use, and combat climate change.
- Social factors assess a company’s impact on its employees, suppliers, customers, and society. These factors include issues such as labor rights, human rights, health and safety, recruitment and diversity, and community relations. Companies should adopt fair labor practices, protect employee rights, prioritize supply chain sustainability, and contribute to the community.
Governance factors It evaluates the company’s management structure, transparency, accountability, and ethical standards. These factors include the structure of the board of directors, shareholder rights, financial reporting, ethical policies, and anti-corruption measures. Companies should act in accordance with ethical values, adhere to transparent governance principles, and prepare their financial reports accurately and reliably.
Why is ESG important?
ESG is extremely important in terms of sustainability. ESG principles enable companies to evaluate not only their financial performance but also their environmental and social impacts. Sustainability is critical to ensuring companies’ long-term success and sustainable growth. Focusing on ESG factors helps companies reduce risks, lower costs, increase efficiency, and strengthen their reputation. Furthermore, investors, consumers, and other stakeholders tend to invest in or prefer companies based on their sustainability performance. Therefore, ESG is an important tool for ensuring the future sustainability and social acceptance of companies.
Furthermore, companies that can better control environmental, social, and governance challenges will be able to achieve a competitive advantage and, consequently, financial stability over the long term compared to other players in the market. This is because companies that take this criterion into account can reduce risks related to legal issues and protect their reputation, as well as attract investors and consumers who are increasingly aware of environmental and social impacts.
Especially since 2015, with the adoption of the Paris Agreement on climate change and the Sustainable Development Goals (SDGs) by the UN to make the world a better place, ESG has become more relevant as legislation on corporate social responsibility issues has developed.
Therefore, it can be concluded that the growing interest in ESG is linked to two main factors:
Increased demand for transparency: After the 2008 financial crisis, not only stakeholders but also the general public and other various interest groups began to demand greater transparency from businesses. Recently, the Edelman Trust Barometer 2021 showed that 86% of the population believes CEOs should be more concerned with social and environmental issues.
Legal requirements: European legislation has become stricter regarding how companies hold themselves accountable. The EU Directive on the disclosure of non-financial and diversity information (2014) led to the enactment of Spain’s Law 11/2018 of December 28 on non-financial and diversity information. This requires companies with more than 500 employees or a turnover of more than €40 million to report on their activities. From 2021 onwards, it will be mandatory for companies with more than 250 employees. An estimated 6,000 European companies will have to prove their commitment to ESG.
Furthermore, companies with high ESG ratings are considered more sustainable and less risky, making them attractive to investors in the long term.
https://aplanet.org/resources/esg-criteria/ – 2023
Measuring ESG Impact Is Challenging—But Not Impossible
Globally, one-third of all professionally managed assets, or roughly $30 trillion, are now subject to ESG criteria. This represents a significant amount, reflecting an increase of over 30% since 2016. Between April and June 2020 alone, investors poured over $70 billion into ESG equity funds, significantly exceeding the previous year’s annual inflows.
These figures reflect a growing awareness among companies, investors, and similarly shareholders that companies need to think about and manage their impact on the planet in new ways in order to sustain their assets. Sustainability is the new aspiration, and according to a rapidly emerging consensus, the key to achieving it lies in developing sophisticated ways to measure ESG activities and impact. In theory, using a robust scoring system, these measurements will compel companies to improve themselves.
However, our current focus on ESG measurement is dangerously narrow. It fails to capture the complex, systemic nature of social and environmental systems and, indeed, of commercial entities themselves. In this article, while acknowledging that measurement is both necessary and inevitable, I will offer guidance on its use and interpretation, as well as what businesses need to do to act effectively on issues threatening our planet and societies.
How Can Measures Be Misleading?
“What gets measured gets managed”—this old logic holds true for most businesses. However, measurement often fails to provide insight into complex underlying processes where important and actionable information can be found.
To do better, we cannot develop increasingly precise measures. Many ESG measures already collect inputs very effectively, but they assume causality—for example, that adding women to senior management teams will produce better results. However, measurements that collect inputs (such as the number of women on these teams) do not capture outcomes (such as decision-making that reflects different perspectives) and impacts (such as the social value created by such decisions). The underlying processes that lead to such outcomes are what we need to pay attention to—this means we need to look beyond the numbers and ask how, why, and under what conditions they emerged.
Measuring what is visible is missing the system
When trying to capture causality, we often draw the wrong boundaries around the problems we are trying to solve. When this happens, measurement can easily lead us astray and make us less capable of taking larger and bolder actions collectively.
Consider what happened in the United States in the 1970s after the government asked car companies to produce fleets of passenger vehicles with higher average fuel economy. The idea seemed smart: first, set fuel economy standards for companies to reduce consumption and emissions; then, measure how well their fleets meet those standards; and finally, raise the standards over time to push these companies to improve. But that’s not how things turned out. The reason is that the government set stricter fuel economy standards for cars than for light trucks. Unsurprisingly, companies began shifting their production from cars to SUVs and trucks. In the 1970s, SUVs and trucks accounted for 3% of all new car sales in the US, but by the early 2000s, that number had risen to over 50%.
All of this led to undesirable outcomes. Emissions did not decrease as much as they should have. Traffic fatalities increased because heavier vehicles collided with lighter ones. More broadly, by demanding measurable improvements in fleet-level fuel economy, the government encouraged automakers to focus narrowly on solving (or avoiding) this specific problem rather than developing broader, more sustainable innovations and solutions. Second, it required fundamentally different capabilities, such as electric vehicles or redesigned models for mobility. Without incentives to develop them, US manufacturers fell behind their foreign counterparts.
There are many similar examples where we focus on a small part of a complex system and, in doing so, find solutions to the wrong problem. ESG measures, especially when measures and investor rewards remain tied to individual companies, can perpetuate this behavior. For example, at the individual level, BP can take credit for reducing its emissions by selling its petrochemical business. But of course, that business and those emissions haven’t gone away.
Measuring what can make money means missing what is valuable
Some things are inherently easier to measure than others. But that does not mean they are more valuable.
CO2 equivalent emissions are one example of this. They are easy to measure and convey the impact of a range of greenhouse gases, for which the cause-and-effect relationship between emissions and climate change is well established, in a single figure. Furthermore, once CO2 equivalent emissions are measured, they can be converted into a carbon price, enabling comparisons between companies and activities.
Capturing and comparing impacts on biodiversity and habitat, where cause-and-effect relationships are much more complex, is much harder. Yet these impacts can be extremely significant.
Consider crop production. Much of this industry, worth hundreds of billions annually, relies on pollinating insects, which are experiencing a serious decline. But measuring what different companies are doing to contribute to this decline is nearly impossible. Various important factors are at play: land use change, intensive agriculture, pesticide use, climate change, disease, and more. But even if such measurements were possible, would they contribute to nature’s value?
Even with clear and comparable ESG measures, there is a significant hubris in allowing today’s investors, asset managers, and business executives to decide what constitutes a good life for our children and what will provide a good life. Changes in underlying values and preferences can fundamentally alter the relevance of even the best ESG measures available.
Beyond Precautions: Keys to Effective Action
These concerns that ESG measurements may obscure important insights about processes, distract us from systems, and dangerously misrepresent broader values do not mean companies should not measure. They should. But they need to do more. Here are three ways they can broaden their focus to gather information not only about inputs, but also about the processes and systems that govern outcomes and impacts.
Zoom in to develop insights about processes
To understand the underlying processes, companies should focus on deeply understanding a few topics most relevant to their core activities. This increases the chance of deeply understanding the causal links that drive greater impact and ultimately directing sufficient resources to act on them.
For example, when Nike was criticized in the 1990s for its suppliers’ labor practices, it took time to interview 67,000 workers to uncover the issues, drawing on the research network and experiences provided by board member Jill Ker Conway and women’s organizations. Building on this, the company was able to develop a longer-term strategy that included making statements, partnering with other brands to improve working conditions, and mobilizing community support.
Zoom out to see broader systems
Stepping back provides a longer-term and broader perspective on issues that require deep insight. Starting from the end state and soliciting input from various stakeholders are two approaches to understanding systems and one’s role within them.
Consider climate change. Carbon emissions dominate the headlines, of course, but step back and you begin to see the extent to which water stress will be an issue we must confront: by 2030, the world will need 40% more water than it does today. Today. Some companies with agricultural supply chains, such as Cargill, Diageo, and Unilever, have embraced the future of shared responsibility at the watershed level, leading them to develop regenerative agriculture and watershed restoration approaches that include local populations and are adapted to local conditions.
Displacement requires significant participation beyond corporate boundaries and must also touch on different perspectives, ensuring that a company learns from and with others about collaborative approaches to systemic issues.
Value curiosity and learning
Many people are calling on companies to set a purpose beyond profit maximization so they can better serve societal values. However, purpose is meaningless without the capacity to implement it. Starting to focus on “doing” is a more grounded and potentially complementary approach that leverages existing capabilities and talents.
Despite the circular economy’s promise to reimagine how we think about waste, some entirely unpleasant possibilities have been unlocked by companies that stubbornly learn from what their frontline workers do. Years ago, Xerox repair technicians and engineers discovered that simple parts in leased photocopiers—plastic spool wheels or metal brackets—could be redesigned to fail less often and be reused even after failure. Similarly, Patagonia knows that zippers wear out much faster than the fabric. Leveraging the repair team’s wisdom helps the company rethink its product design so that zippers can be replaced without ruining a down sleeping bag or jacket.
The common thread among the above is an emphasis on doing and learning—that is, not being guided solely by metrics. Robust ESG and impact measurements can help us maintain our score and make course corrections when necessary. However, ultimately, no matter how or what we measure, we must continue on our path toward greater understanding, insight, and even purpose.
https://hbr.org/2021/01/esg-impact-is-hard-to-measure-but-its-not-impossible
ESG Criteria
ESG criteria refer to a broad set of criteria that measure the sustainability and ethical impact of an investment in a company or business. ESG stands for environmental, social, and governance.
Environmental Criteria
- Climate change
- Greenhouse gas emissions
- Resource depletion
- Waste and pollution
- Deforestation
- Biodiversity loss
Social Criteria
- Inequality
- Inclusivity
- Labor relations
- Investment in human capital and communities
- Human rights
- Modern slavery
- Child labor
- Working conditions
- Personnel relations
Governance criteria
Including governance of public and private institutions,
- Management structures
- Employee relations and
- Executive compensation
- Bribery and corruption
- Board diversity and structure
- Political lobbying and donations
- Tax strategy
- Regulatory guidance on the use of ESG criteria in lending
Institutions should adopt a holistic approach to incorporating ESG factors and related ESG risks into their credit risk appetite and risk management policies, credit risk policies, and procedures.
Institutions should consider the risks to the financial conditions of borrowers associated with ESG factors and, in particular, the potential impact of environmental factors and climate change on credit risk, policies, and procedures.
Climate change risks for borrowers’ financial performance can materialize as physical risks, such as risks to the borrower arising from the physical impacts of climate change, including climate change risks, responsibility for contributing to climate change, or transition risks.
https://www.openriskmanual.org/wiki/ESG_Criteria
ESG Criteria in Engineering
Instrumentation specialists are pivotal in reducing our impact on the environment. For example, good PID control cuts pump speed based on flow data. This saves power, reduces wear and tear, and thus contributes to sustainability. Similarly, remote monitoring translates into fewer site visits, which reduces emissions (and saves money).
The devil is always in the details, but when dealing with environmental issues and climate change, there are generally two overarching approaches. The first is mitigation: reducing emissions and protecting infrastructure to offset the inevitable effects of climate change.
These approaches are not mutually exclusive; both should be considered and adopted. For example, renewable energy sources or recycling water would be considered mitigation. On the other hand, adaptation may involve protecting a region and its infrastructure from frequent flooding and higher temperatures. Obvious solutions would include moving equipment to higher ground and adjusting building specifications.
There are two more ESG standards to consider. Changing a company’s personnel structure may jeopardize productivity, but social principles can be achieved. An alternative approach is to develop training programs. Using your organization as an example, explain how technologies can help other industries reduce emissions and waste and increase energy efficiency. Or provide workshops on STEM topics at your local school or community: targeting women and social groups underrepresented in the engineering industry. After all, knowledge in STEM and industrial automation is becoming increasingly relevant and useful.
The ultimate standard—governance—can be achieved by emphasizing ethical best practices in every action through open and transparent communication.
Ultimately and finally, curiosity and learning should be valued in engineering industries with greater awareness of ESG. Instrumentation professionals are strong analysts, intensely focused on measurement; therefore, they are exceptionally well-positioned to further advance the inherently good values inherent in ESG.
https://www.eit.edu.au/the-next-big-driver-for-instrumentation-and-control-the-esg-criteria/
