What is ESG: Environmental, Social, and Governance Explained

ESG are three letters you might want to know. ESG, which is an abbreviation of Environmental, Social, and Governance, is a term that has sparked both popularity and controversy over the past couple of years in the trading and investing communities. So what is ESG, what does ESG stand for, what is ESG investing, and how do we define ESG? Let’s find out:

TL;DR

• ESG (Environmental, Social, Governance) is a series of criteria framework used to assess a company's sustainability and ethical impact across environmental, social, and governance factors.

• Environmental: Refers to a company’s climate impact, pollution, and resource usage.

• Social: Refers to how a company treats its employees and handles workplace issues.

• Governance: Refers to transparency, diversity, and anti-corruption in a company’s leadership [board] and financial practices.

• ESG investing: Involves investing in companies that meet certain environmental, social, and governance standards.

• Big/Large-cap ESG companies: Microsoft, Apple, Nvidia, and Tesla are among the leading names, with mixed views on Tesla’s ESG score.

• ESG Futures: Financial contracts based on the ESG performance of assets, enabling investors to trade on ESG criteria.

What Is ESG?

So what does ESG mean? To put it simply, ESG is a set of Environmental, Social, and Governance factors used to evaluate the level of sustainability and ethicality companies adopt while operating. Investors and traders may refer to a company’s ESG score in order to find out how responsible their investment is in a company’s shares. The three different criteria are as follows:

Environmental 

Environmental factors refer to corporate climate policies, i.e. animal rights, the level of toxic greenhouse gas emissions and waste, deforestation, climate change, pollution, resource depletion, energy use, and more. Furthermore, how much a company complies with environmental regulations is also used to gauge this factor. (Source:Investopedia)

Social 

It might not come as a surprise that social refers to, as the name suggests, the social aspect of a company. In other words, a company’s social responsibility pertains to how well a corporation treats its employees, and how legal the work environment is regarding health and safety measures and standards, employee relations, conflict, and working conditions. Therefore, if a company has a ‘social license,’ which is essentially how much the employees accept and consent to the company's practices, also indicates if the company adheres to the social factor. 

Governance 

Last but not least, governance standards refer to the accuracy and transparency behind a company’s accounting and financial methods, how its board is run, and how far a company is willing to go in order to create diverse and equal work opportunities. Tax strategies, stance on anti-corruption and preventing bribery, board diversity, and hierarchy are some of the elements that go into calculating a company’s adherence to governance benchmarks. 

What is ESG Investing?

In order to familiarize yourself with ESG, you can compare it to purchasing a new set of shoes. Some of the criteria you might want to consider before purchasing a new pair of shoes, for example, are comfort and pricing, and for some people, they might want to consider whether a brand is vegan-friendly, moral towards its employees, and transparent. Similarly, when investors and traders seek to buy or sell CFDs on a certain company’s shares, for example, they might want to weigh the latter’s ESG score, i.e. how much a company is ecologically, socially, and economically responsible. 

ESG Companies: Big Names Devoted to ESG

Some of the biggest (by market-cap) and most committed companies to ESG, are tech giants Microsoft (MSFT), Apple (APPL), Nvidia (NVDA), Alphabet (GOOG), and chain store behemoth Costco (COST) among others. It has even been reported that cloud providers like Microsoft Azure and Google Cloud are leading the way toward carbon-free and zero-emission computing. This is because while cloud providers usually generate greenhouse gas emissions that intensify global warming, Microsoft Azure and Google Cloud have released tools that gauge the estimated carbon dioxide emissions. Furthermore, these two cloud providers can be used by companies to meet ESG requirements.  Microsoft announced its intention to become carbon-negative by 2030. Subsequently, in January 2020 the company allocated $1 billion for the development of carbon reduction. And as of late, on July 13th, 2022, Microsoft signed up to a 10-year agreement with Climeworks as a serious step toward going carbon negative by 2030 and removing CO2 emissions by 2050.  To explain the pivot toward ESG, in June’s ‘Sustainability Summit,’ Google Cloud CEO Thomas Kurian explained that “consumers, employees, investors, and policymakers are demanding that organizations prioritize sustainability and be transparent about the impact they're having on the environment and the progress they're making on their sustainability initiatives.”

Is Tesla an ESG Stock?

While the answer to ‘is Microsoft an ESG company?’ seems to be more or less straightforward, the question of whether Tesla (TSLA) is more complex. This might come as a surprise given the fact that Tesla is a leading electric vehicle manufacturer;  therefore, the company is considered an ESG company. This is due to its operations (EVs, renewable energy and energy storage) having a positive impact on the environment, falling under the ‘E’. The ‘S’ and ‘G’ remain under debate due to the company’s history and skepticism around labour practices, alleged discrimination and corporate governance. Nonetheless, the EV maker’s ESG score is not black or white. While Microsoft is part of the S&P ESG index, earlier this year, Tesla’s shares got excluded from it. This, in turn, raised the question of whether Tesla is really an ESG stock or not. Furthermore, Tesla’s CEO, Elon Musk, might have increased the dubiousness and controversy surrounding Tesla’s ESG status when he revealed in a tweet on May 17th that “ESG is a scam. It has been weaponized by phony social justice warriors." (Source:Twitter)

Why Is ESG Important? 

One can argue that ESG is important because for companies to have some ESG standards is a good thing for the environment and for society as a whole. While companies may not be able to reverse the already-present ecological crisis, they can definitely attempt to comply with ESG guidelines and hence limit their carbon footprint in order to minimize the harm. Moreover, some believe that ESG grants companies the ability to increase their customer base by giving them more access to capital resources. In addition, such practices can increase social credibility. 

Whether or not more companies will be able to sustain the path of ESG is yet to be determined. Nonetheless, it is important to note that while this is a growing domain, there is still controversy around it. 

Conclusion 

In conclusion, ESG is an increasingly important framework in the world of investing, as it considers the sustainability and ethical practices of companies. While many corporations are aligning themselves with ESG standards, the debate around the effectiveness and sincerity of these efforts continues, with some companies, like Tesla, under scrutiny. ESG Futures, which are a relatively new financial instrument, allow investors to trade based on a company’s ESG score, providing another tool for those who wish to invest responsibly.

*Past performance does not reflect future results.