How do you use ESG criteria to make investment decisions?

ESG metrics / criteria is not uniform globally and lots of heterogeneity is present due to more than 60 plus performance standards on ESG. As a solution to this in COP26 at Glasgow , IFrS was asked to set interoperability and bring global benchmark atleast on climatic disclosures. As a result from July 2023 - ISSB is in force and being adopted by various organisations / institutions and countries in the next couple of years. Still the SASB 26 criterion with risk map as per industry along with standards of GRI 2021 , TCFD are good objective standards for ESG criteria book. In India the foundation was set by NGRBC in 2019 and rolled out by SEBI as BRSR for top 1000 listed companies in India !

ESG criteria is quite broad and depends on the operations, geographical settings and consumption pattern. However there are various principles which shapes up ESG criteria like WEF PS, UNGC, ILO just to name a few. Many sovereign rating agencies and fund houses have created their own assessment criteria taking clue from above mentioned over arching principles. The FCDO tool kit, ESMS of WB to name a few. Once various indicators are finalised and segregated into E, S and G there comes role of reporting standards which gives a clear narrative what to report and how to report. Like BRSR, GRI. Suppose Basis the operations water, energy comes out to be assessment criteria than as per GRI section 300 and as per BRSR principle 6 can be referred.

There is something to be said about the comparability of ESG criteria especially with different third party agencies/ index providers. The metrics, threshold set could vary significantly. This means there could be a scenario where one company is rated favourably by one ESG index and not so by another.

When you consider the key elements of manufacturing these 6 are by default 1. Customers 2. Employee 3. Vendor 4. Banks or investors 5. Government and compliance 6. Market ecosystem and technology Lastly the important stakeholder is mother EARTH If we build sustainable business with sustainable products and services mother EARTH will also support the well-being of the society (S). To keep this check in balance we strong Governance (G) which is committed to a goal.

ESG criteria just provide additional information and transparency about companies and investments that are material to their performance.

While E & G of the ESG paradigm are still easier to assess, it’s the ‘S’ which often baffles the investors. Another problem is that of lack of a tangible impact measurement framework. How to measure the ESG efficacy of your investment? A way forward would be to invest in businesses which create overall positive impact, which proactively work on a ‘Greening’ their business models (zero plastic, circularity etc.); create dignified jobs, maintain a transparent management etc., even though impact agnostic. Another is to choose the sectors in which one invests carefully so that the financial ROIs do not overshadow social & environmental ROIs and the businesses creating negative impact can be shunned altogether.

ESG criteria adoption in my experience is to have IMPACT on all stakeholders who are looking for energy efficient goods/ services which have not been human rights compromised and / or devoid of corruption /bribery in their supply chain. All 3 pillars of E,S,G definitely then attracts investors , employees and customers . Especially post events like 2008 meltdown , me too movement , Black Lives Matter , Covid 19 and numerous storms , earthquakes etc have pushed the ESG criteria integration .

Why to use ESG criteria is a very fundamental question now a days. With the recent report on planetary boundaries to ever felt climate change phenomenon, the social implications and governance failure has a clear indication that the money need to be spent on those projects and initiatives which can have a net positive impact. On what we will invest today, that is going to shape our the future for next generations. It automatically becomes a fiduciary duty and responsibility of the stake holders to be accountable to today’s as well as the upcoming generations. It has become imperative to evaluate using ESG criteria which will make the decision making easier, better and more sustainable.

For long term sustainable journey of the business we need to use ESG as part of vision and mission. Watch out the apple companies commitment to build all their products by 2030 to be sustainable with zero plastic. Which means their entire supply chain is sustainable. Huge commitment and a true leadership position to drive sustainable products. Those who care for climate change and mother EARTH will become Apple dedicated customers. Earlier Apple drove customers by technology and features now in addition they are driving customers by responsible and being accountable. This means this community will demand more ESG products. Such an incredible agenda and noble vision to drive.

For all of the stated reasons, and aligning investors values with their portfolios gives them a deeper connection to their investments reinforcing better financial behaviors, which result in a higher probability of reaching their goals.

There are a few methods adopted when it comes to using ESG criteria: a) negative screening-for those who are involved in what are seen as sin industries (harmful to Environment or Society) b) positive screening-where a score is govem to companies that have successfully met a criterion c) mixed methods-a combination of negative and positive filters Bear in mind that these methods are seen as deterministic, there are also other methods that incorporate uncertainties in value judgements

ESG strategy in developing countries like India are still shaping up. India as a startup market is huge, investments in India has huge potential, however, the Indian startup ecosystem is still largely unaware of ESG guidelines and it's value creation. It will take sometime for markets like India and other developing countries to fully absorb the ESG impact.

Indeed, the integration of ESG criteria into decision-making processes presents complexities. The absence of a unified framework often leads to discrepancies in ESG data interpretation and reporting. Moreover, the diverse methodologies employed by rating agencies can result in inconsistent ESG evaluations. Balancing conflicting ESG elements further adds to the challenge. Stakeholders must approach ESG with a discerning eye and a comprehensive understanding of these intricacies.

Greenwashing, where firms overstate their environmental efforts, complicates the use of ESG criteria. As companies recognize the increasing value stakeholders place on sustainability, some might present their initiatives more favorably than they truly are. The absence of a standardized ESG reporting framework further muddies the waters, enabling these embellishments. For investors and stakeholders, this poses challenges in differentiating genuine commitments from misleading narratives, necessitating a deeper, more critical examination of ESG claims.

Negative political exploitation of ESG and mischaracterizations. Inconsistent reporting and “greenwashing.” Possible conflicting values between E, S and G. Others trying to impart their personal values into the equation.

In my experience for each company - it’s a unique ESG DNA which needs to evolve. For eg - one should have their own primary SDGs - it’s own alignment Journey timeline to 26 elements of SASB etc. All actions need to be in letter and spirit ! Not to greenwash claims and bring numerical metrics for rewards ! Challenges would disappear into oblivion with a passionate professional approach to ESG.

You over come the challenges by first committing to a sustainable goal. Look at Apple and their commitment. Once you jump in you will find your path.

Metadata analysis and understanding the limitations of the data and where it is coming from. Accepting that ESG is defined differently by each individual and trying to best incorporate those perspectives. Focusing on the desired impacts that ESG criteria are seeking to improve.

ESG vs CSR vs Sustainability - they are not the same. Practitioners and companies should not interchangeably use these terms - it adds to confusion for stakeholders.

ESG is not a fad or political statement. It is an extension of transparency and provides more and better information to help guide our decisions, mitigate risk and help us reach our shared goals to make this world a better place.

ESG factors are material and pecuniary long term and should be considered as fiduciaries. Transparency and full disclosure provide necessary information to make more educated and better decisions.

How we use ESG criteria to make investment decisions it is very difficult with increasing concerns over potential ESG product greenwashing. For avoiding this I recommend all interest and working on this field get the certificate in ECG investing from CFA Institute to know more about the ESG criteria and to have capability to make investment decisions