Tuesday, August 29, 2023

The Ethical Blueprint: Embracing the ESG Mandate Overview: ESG stands for environmental, social, and governance. It is a framework used to assess an organization's performance on sustainability and ethical issues. It also provides a way to measure business risk and opportunities in those areas. ESG factors include climate change, pollution, human rights, labor practices, and corporate governance. ESG is becoming increasingly important for businesses and investors. A growing number of consumers and investors are demanding that companies take ESG factors into account. This is because ESG factors can have a significant impact on a company's long-term financial performance. Components of ESG – (A) Environmental: This refers to a company's impact on the environment. Key considerations under this pillar include climate change, deforestation, biodiversity, renewable energy, waste management, water conservation, and pollution. • Greenhouse gas emissions: Companies that emit a lot of greenhouse gases are contributing to climate change. This can lead to a number of negative consequences, such as rising sea levels, more extreme weather events, and food shortages. • Water usage: Companies that use a lot of water can put a strain on local water resources. This can lead to water shortages and other problems. • Waste disposal: Companies that produce a lot of waste can pollute the environment. This can lead to health problems and other environmental damage. (B) Social: This dimension revolves around how companies manage relationships with employees, suppliers, customers, and communities. It covers aspects like human rights, labor standards, health and safety, and community engagement. • Labor practices: Companies that have poor labor practices may exploit their workers. This can lead to a number of problems, such as low wages, unsafe working conditions, and child labor. • Human rights: Companies that violate human rights may harm their employees, customers, and suppliers. This can lead to a number of problems, such as discrimination, forced labor, and environmental degradation. • Diversity and inclusion: Companies that are not diverse and inclusive may have a negative impact on their employees, customers, and suppliers. This can lead to a number of problems, such as a lack of innovation, low morale, and poor customer service. (C) Governance: This refers to a company's internal controls and corporate structure and largely revolves around topics like corporate board diversity, executive remuneration, audits, internal controls, shareholder rights, and transparency in financial reporting. • Board composition: Companies with boards that are not diverse and independent may be more likely to make poor decisions. • Executive compensation: Companies that pay their executives too much may be less likely to invest in their businesses. • Shareholder rights: Companies that do not respect shareholder rights may be less likely to be accountable to their stakeholders. The three pillars of ESG are interconnected. For example, a company with poor environmental performance is more likely to have poor social and governance performance. This is because environmental problems can often lead to social problems, such as pollution and climate change. And poor social and governance performance can also lead to environmental problems, such as deforestation and water pollution. Why is ESG important for companies: Adherence to good ESG practices is important for companies for the following reasons- • Risk Management: Companies with strong ESG performances are perceived to have better risk management practices. This reduces the vulnerability to regulatory, legal, and societal changes. • Performance and Competitiveness: Studies suggest a positive link between ESG and financial performance. Moreover, companies that adopt ESG practices can attract and retain top talent, ensuring competitiveness in the market. • Long-Term Vision: ESG-focused companies and investors often think long-term, prioritizing sustainability and enduring value creation. • Stakeholder Trust: Companies that adhere to ESG principles tend to enjoy enhanced trust among stakeholders, including consumers, employees, and the community at large. Rating criteria: ESG scores are typically calculated by combining a company's performance on multiple ESG factors. The scores are then used to rank companies from best to worst in terms of their ESG performance. ESG scores can be used by investors and companies to make decisions about investments and business practices. Investors can use ESG scores to identify companies with strong ESG performance. Companies can use ESG scores to identify areas where they can improve their ESG performance. To assess a company's ESG performance, several rating agencies have emerged, each with its methodology. However, common criteria include: • Disclosure and Transparency: How openly a company shares its ESG data and practices. • Absolute Performance: Evaluation of a company’s ESG data in absolute terms. • Relative Performance: Comparing a company's ESG performance against its peers. • Direction of Change: How a company's ESG performance is evolving over time. Aditya Birla Money Ltd, a responsible research house have started publishing ESG score in their research reports. The reports use Crisil/Bloomberg ESG scores to benchmark the performance of companies on ESG parameters. The companies are assigned a score between 0-100 gauging a company's commitment and effectiveness in addressing sustainability and ethical practices. A score of 0 indicates a complete lack of ESG initiatives and possible neglect of environmental, social, and governance responsibilities, while a score of 100 represents an exemplary commitment to sustainable and ethical practices in all ESG domains. Companies that score closer to 100 demonstrate a higher dedication to sustainable business practices, stakeholder engagement, and governance transparency. These scores are further categorised in 7 grades ranging from Poor to Ideal for graphical representation on a colour scale as demonstrated below0-14 (Poor), 15-28 (Below Average), 29-42 (Average), 43-56 (Adequate), 57-70 (Above Average), 71-84 (Strong) and 85-100 (Ideal)

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