Environmental, Social, and Corporate Governance (ESG) are three of the central factors which are used to assess the impact of sustainability and ethical practices of a company in relation to its financial performance and general operations.
As you might expect, the Environmental factor is concerned with how a company performs in terms of protecting the natural world. The Social factor considers relationships with employees, suppliers, customers, and the community itself.
Lastly, Corporate Governance relates to factors such as leadership, their pay, any audits, shareholder rights, and internal controls, which helps to promote accountability and prevent fraud. The ethical benefits are just one aspect to consider, as it also allows investors to better predict the financial performance of companies in the future.
Here are some of the most important frameworks for ESG in the financial sector, including information about each one, and what they aim to achieve.
Five important frameworks to tackle ESG factors
An ESG framework can be used to measure the potential for risk, whether it be due to financial issues, or poor environmental practices. We have listed the following frameworks in order of importance in relation to ESG factors.
EU taxonomy for sustainable activities
The EU taxonomy is arguably the most important framework for helping the financial sector to conform to ESG guidelines. They’ve set three clear thresholds to improve environmental objectives.
The first is to make a substantive contribution to at least one of the following six objectives;
- Climate change mitigation
- Climate change adaptation
- Sustainable and protection of water and marine resources
- Transition to a circular economy
- Pollution prevention and control
- Protection and restoration of biodiversity and ecosystems
They should also work to ‘do no significant harm to the others while meeting relevant minimum safeguards.
TCFD
Next up is the Task Force on Climate-related Financial Disclosures (TCFD). They “develop voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders.”
It’s easy to see how they can be used to better consider various ESG factors pertaining to financial risk. It’s more of a general framework for climate issues, but it’s still worth considering, especially if you want ‘investors, lenders, insurers, and other stakeholders’ to have more confidence in the financial stability of a business. Read more about TCFD.
PRI
The UN Principles for Responsible Investment (PRI) has two main aims;- To understand the investment implications of environmental, social and governance (ESG) factors
- To support its international network of investor signatories in incorporating these factors into their investment and ownership decisions
As a leading proponent for ensuring investments are responsible, they’re working to improve both the markets in which they operate, as well as wider society. Of course, it’s an EU-centric framework, but it’s helpful for businesses that operate within those markets.
SDGs (Sustainable Development Goals)
The SDGs, or Sustainable Development Goals are some of the best-known frameworks for understanding ESG. It consists of 17 interconnected Goals, with an overall aim to achieve each one by 2030.
It’s an aggressive timescale, but they’ve helped to provide an easy blueprint for companies and businesses to follow.
EU Green Bond Standard
Another method to regulate sustainable finance, the EU Green Bond Standard is a tool which will be used to ensure that economic investments have a ‘real-world environmental impact’.
After all, there’s no point in enacting changes if they have no real positive effects. The EU Commission plans to mobilise at least €1 trillion in sustainable investments over the next decade to help to meet goals, and the Green Bond Standard could help in this regard.
Green Loan Principles, from The Loan Market Association
Finally, there are the Green Loan Principles (GLP). Comprising voluntary recommended guidelines, they aim to identify “the instances in which a loan may be categorised as ‘green’.”
Green loans have continued to increase in recent years, as more money is poured into sustainable ventures. For example, it’s estimated that in 2018, one in every four dollars invested in the U.S. was attributed to a sustainable, responsible or impact (SRI) investment strategy.
That number is expected to grow over the next decade, along with the relevance of GLP.
ESG frameworks in the financial sector: conclusion
There are a variety of ESG frameworks which are tools that help companies to better understand the regulations and contributions that they are expected to make over the next decade, and beyond.
The EU is clearly eager to regulate the financial sector, while careful consideration of ESG factors should make it easier for them to do so.
There are also various services which rate the ESG of a company, such as Sustainability. They aim to influence and improve the quality and transparency of corporate sustainability ratings, and it can be a helpful tool to understand how a business is doing in terms of ESG.
Many companies use information from the likes of Bloomberg and MSCI. For example, the latter (MSCI ESG Research) uses 1000 data points to rate “companies on a ‘AAA to CCC’ scale according to their exposure to ESG risks and how well they manage those risks relative to peers.”
The majority of the frameworks are optional, and they should help companies in the long-term, while improving the quality of the markets themselves.
Rather than a limiter or an inhibitor, they should be viewed as tools that can help companies onto the right track, safeguarding them against further regulations in the future.
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