The term ESG stands for environment, social, governance and is often used in relation to sustainable investment products. ESG criteria can be used to select stocks to include in or exclude from a portfolio of sustainable investments.
There are no standard definitions or weightings for ESG criteria. Many financial players have developed their own systems for rating sustainability.
Common criteria related to the environmental sustainability:
- Pollution (may include CO2 emissions).
- Consumption of energy and resources (scarce commodities, for example).
- Waste creation.
- Waste management.
- Use of animals.
Common criteria related to social sustainability:
- Health and security of employees.
- Job security.
- Sponsorship and social engagement (voluntary work, for example).
- Human rights policies (in relation to child employment, for example).
- Diversity.
- Equality with regards to salaries.
Common criteria related to corporate governance:
- Illegal business practices (cartel agreements, for example).
- Transparency in accounting.
- Investor participation in important corporate decisions.
- Supervisory structures.
- Conflicts of interest.
- Influence on politics.
- Risk management.
Many investment products which are marketed as sustainable only fulfill some ESG criteria. For example, a sustainable fund may focus primarily on environmental themes without accounting for the salary structures of companies it invests in.
In most cases, the administration and review of ESG ratings is performed by companies which partner with banks. In Switzerland, for example, Inrate is an established sustainability rating provider. In the United States, ESG ratings from MSCI – a subsidiary of Morgan Stanley – are widely used. MSCI also publishes indexes for sustainable exchange traded funds (ETFs), based on its own ESG criteria.
Many ESG rating providers argue that they also consider the financial risks associated with ethical factors. For example, unethical business practices resulted in Volkswagen’s diesel scandal which generated billions of francs of costs for the company. According to this principal, accounting for ESG criteria can help to avoid unnecessary risks.
More on this topic:
Questions and answers about sustainable funds
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