Jargon Buster: ESG - Environmental, Social and Governance Criteria

What are environmental, social, and governance criteria?

Environmental, social, and governance (ESG) criteria are company standards to help socially-conscious investors screen potential investments. They help investors find companies with values matching their own. ESG criteria also help investors steer clear of companies that could pose a financial risk through their environmental, social or other practices.

Environmental criteria cover a company’s actions as a steward of nature. Social criteria focus on a business’s relationships with its employees, suppliers, customers, and within the communities where it operates. Governance covers a company’s leadership, executive pay, audits, internal controls, and shareholder rights. 

ESG investment is also known as sustainable investing, responsible investing, impact investing, or socially-responsible investing. 

Why are ESG criteria increasingly popular?

ESG criteria are growing in popularity as a way for investors to carefully assess the companies they want to invest in. Younger investors in particular have recently shown greater interest in placing their funds into companies that reflect their values. Following this trend, many brokerage firms, mutual funds and robo-advisors now offer financial products that include ESG criteria, such as exchange-traded funds (ETFs).

How ESG criteria work

Investment firms following ESG criteria set priorities for their investment funds and investors examine company behaviours to assess their values in practice. It’s unlikely for a company to pass the criteria in every single category, so it’s up to investors to decide what matters most to them.

Environmental criteria includes a company’s attitude towards energy, waste, pollution, natural resources, conservation and animal treatment. The criteria are also useful for evaluating any environmental risks a company faces and how they’re managing them. For instance, are there issues with the company owning contaminated land, disposing of hazardous waste, managing toxic emissions or complying with environmental regulations?

Social criteria examine a business’s relationships. They include whether a company works with suppliers that share their values and whether a company contributes a proportion of its profits to charity. Social criteria also cover staff, such as whether the working conditions reflect a high regard for employee health and wellbeing.

Governance explores whether a company uses accurate and transparent accounting methods and how, or if, stockholders can vote on key issues. Potential investors may also seek assurance that a business steers clear of conflicts of interest when they’re selecting new board members, they don’t give political contributions in exchange for favorable treatment and— of course — that they don’t engage in unlawful activities.

Stay tuned for our next bi-weekly jargon-busting article!