The ESG Explainer: The Value of ESG Data

How Can Companies Use ESG Data?

Environmental, social and governance metrics — customarily abbreviated to ESG — have been around for more than a century. ESG primarily originated with socially conscious investors who wanted to align their investments with their values. In recent years, however, with the emergence of more and better data — plus an increased understanding of the environmental and social pressures of modernity — ESG data has become mainstream.

The pressures that have helped put ESG in the spotlight include macro drivers like increased resource scarcity and impacts on productivity from disaster events, such as the 2021 winter storm “Uri” in Texas, which caused over $10 billion in insured losses and crippled Samsung’s plant in Austin for more than a month. They also stem from increasing expectations that corporations should commit to improving social outcomes — ranging from addressing inequality, diversity representation, and several of the socially-oriented United Nations Sustainable Development Goals (SDGs).

ESG data tends to capture extra-financial factors that were traditionally absent in financial analysis: company management of energy and water use, waste generation, employee rights and working conditions, community engagement, data privacy rights, and more traditional indicators of corporate accountability and transparency. ESG encapsulates almost everything that may reflect how companies are operating within society and the environment, and if that mode of operation is “sustainable” and “responsible.”

ESG factors may be increasing in importance, but how exactly should companies be considering and using them? The answer is as wide-ranging as the data itself, but can be summarized into three main arguments.

1.  ESG Is a Valuable Risk Management Tool

Operationally, this translates to efficient use of resources or saving money by upgrading to more efficient equipment and energy. The data center industry provides good examples, such as Microsoft, which designs its data centers to prioritize water efficiency; it places data centers underwater to avoid cooling costs or chooses air cooling in water-stressed areas like Arizona.

Regulation around ESG has increased dramatically in the last few years, prompting companies to consider ESG risks for the first time. According to the UN PRI responsible investment regulation database, 95% of regulatory policies were developed after 2000, with significant increases after 2010 (see table below).

Other sustainable investment regulations, such as the EU taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), and Non-Financial Reporting Directive (NFRD) are putting pressure on European companies by mandating disclosures on ESG issues. For example, the EU’s Corporate Sustainability Reporting Directive (CSRD) has taken effect as of 2023 with the first reports due in 2025.

Social-related disclosure is also increasing. Corporate diversity laws enacted in Illinois in 2019 and California in September 2020 aim to increase racial diversity on the boards of publicly traded companies. In late 2023, a survey of corporate diversity, equity, and inclusion (DEI) reports found that 154 reports had been published by Fortune 500 companies compared to 79 reports in 2022. 

Reputational risk is also a driving factor. The majority of companies’ value today comes not from real assets and equipment, but intangible value in the form of intellectual property and brand equity — making reputational management a financial consideration. Recent social and governance controversies from prominent companies across a range of industries — and environmental ones, like the response from a top oil and gas company to a Dutch court that had ordered it to slash emissions — show that companies failing to adapt to changing expectations can experience a decrease in stock performance as well as brand damage.

2.  ESG Creates More Options for Capital Allocation and Attraction

While focusing on ESG-related issues can result in improved operational efficiencies and risk avoidance, it also can provide new venues for capital attraction. Banks are increasingly providing preferred lending rates to companies with good ESG performance, such as Deutsche Bank, which is offering lower interest rates to lenders if agreed-upon ESG targets are achieved. Green bonds have been purchased at a premium by investors who are hungry for sustainability-related investment vehicles. Green and sustainability bonds (bonds that address both environmental and social factors) have also been a helpful financial tool. Apple, Starbucks, Toyota, and Alphabet have all issued such bonds to raise capital for their sustainability initiatives.

ESG issues are also increasingly included in credit risk considerations; in Europe, this is being accelerated by new guidelines stipulated by the European Banking Authority. These guidelines went into effect at the end of 2022 and require banks to factor ESG-related risks within the financial conditions of borrowers.

3.  ESG Is Becoming an Essential Part of Institutional Investing Decisions

While many companies are learning about ESG for the first time, major financial players have been watching the trends and are already integrating ESG into their decisions. Major asset managers beyond the climate-vocal BlackRock, including CalPERS, Calvert, GPIF, APG, and others are using increasingly sophisticated methods to leverage ESG in their investment decisions. Nasdaq has started to incorporate ESG when evaluating IPOs, and stock exchanges across the world, such as the Hong Kong SAR, Shenzhen, Shanghai and Philippines stock exchanges, are making ESG disclosure a requirement for being listed. When the largest investors and companies in the world are asking for this type of information, it’s only a matter of time until the disclosure requests reach into their supply chains and the activities of private companies.

Global complexity is increasing as supply chains become more interconnected, economies grow and develop, weather patterns change, and societies experience and acquire more sophisticated technology. ESG data is an attempt to capture more of this complexity in business decision-making and to assess potential for continued viability in a world that increasingly requires more sustainable outcomes.