Environmental, social, and governance (ESG) is a hot topic right now. And like all hot topics could use some definition and a reality check.
What is ESG?
At its core, ESG is an evaluation tool used by investors and lenders to identify sustainable, low-risk, and socially and environmentally responsible investments. ESG is a series of non-financial criteria that firms such as Moody's and S&P Global use to assess and rate companies on their ability to manage and subvert ESG-related risks.
These ratings codify how an organization's ESG policies and actions affect their shareholders financially. The ratings are used by investors as part of their decision-making process of where to allocate their capital. ESG can also be used as a proxy by regulators and governments to ensure organizations comply with environmental or social mandates.
The exact ESG criteria investors and regulators look for can vary, but the table below highlights some of the most common policy areas or metrics they prioritize.
ESG originated at the United Nations (UN) in 2005 as the foundation for the UN's "Principles for Responsible Investment." These are six principles that guide investors to act in the "best long-term interests of their beneficiaries." Currently, there are over 5,000 signatories of the principles, representing $121 trillion in assets under management.
Is ESG a fad?
This may all feel slightly familiar. After all, for the past few years the direction of travel for most sectors has been toward working with enhanced social justice as a leading output. Throw in heightened scrutiny around environmental impact and suddenly ESG criteria doesn't look all that different from the strategic priorities of many companies.
In essence, what ESG and its analogues/predecessors like corporate social responsibility (CSR) actually address is improving long-term value.
Commentators expect ESG to continue emerging as the primary framework used by investee organizations to stratify their social and environmental commitments. It's easy to see why—ESG is more financially quantifiable than other mechanisms and investors and regulators prefer ESG as it gives them a more tangible representation of the sustainability of a business.
A good ESG rating provides access to lower rates from lenders. As organizations—like hospitals—often need sustainable and affordable access to capital, showing their strong performance in ESG criteria means they can acquire loans at a reduced rate. And for lenders, they are willing to risk lower returns in aid of improving the sustainability and lowering the risk of their products. So, it sounds like it benefits both sides, right?
Yes. But it's not all plain sailing for ESG.
Rating agencies have come under scrutiny due to a lack of transparency in their ratings methodologies. This leads to highly variable ratings that sometimes reward organizations with good ratings because they "ticked ESG boxes" without showing positive environmental or social outcomes (think greenwashing). Issues also arise if rating agencies use certain ESG criteria that are irrelevant for certain businesses or industries, leading to lower ratings that are beyond the investee's span of control.
Naysayers suggest that ESG offers nothing more than other long-term value drivers such as management quality or corporate culture. They argue that ESG shouldn't be prioritized over these other value drivers, that investees shouldn't specifically work on improving ESG factors if they wouldn't do the same for these other drivers. They say investees shouldn't use ESG just to benefit from enhanced investment opportunities, they should do it with the outcomes to society at the top of the agenda.
ESG was intended to be an evidence-based process of investment selection instead of a value-based decision-making progress. But it is the view of ESG as a set of long-term value factors that is driving its emergence as a dominant practice. As one commentator puts it "Considering long-term factors when valuing a company isn't ESG investing; it's investing."
Regardless of the terms we use or the buzz around different concepts, value-drivers like ESG simply reinforce the direction of travel of most organizations—toward responsible social and environmental business practice. ESG only differs in that it introduces more quantitative formality to this practice and provides financial opportunity for organizations who adhere to it.
A lot of the hype around ESG is focused on the corporate governance side, but there are clear implications, and potential opportunities for health care specifically. We will discuss these in part two.