What is and why ESG factors?

In the recent past, it was thought that the main goal of investors and the business in which they invest was to maximize short-term returns for shareholders, without taking into account factors such as the social or environmental impacts of the business. In 2021, this already seemed inadequate, and the crises of recent years have forced more and more companies to reconsider this basic dogma and include the public interest in their approaches. This is how the sphere of CorporateSocial Responsibility (CSR) appeared, and today in 2022. ESG (Environmental, Social and Governance) is already being talked about everywhere, as a cornerstone of Sustainable and Responsible Investing (SRI). The meaning of ESG is much broader and includes criteria for how sustainable a deal, an entire company or even an industry is.

     The concept is even developing in the form of a rating to enter various spheres of society and become a major factor in business – if a company has a high ESG rating, with a clear strategy for decarbonization of activities and climate neutral development, it will receive more -profitable financing, will pay less fees, will be more attractive to employees, etc. ESG refers to three main factors for measuring the sustainability of investments – environmental, social and corporate responsibility. This approach stems from the concept of the Triple Bottom Line, also known as „People, Planet, Profit“ (PPP – People, Planet, Profit), introduced in the 1990s to draw companies’ attention not only to profits, but also to each “P” in the equation, which ultimately leads to the sustainability of any commercial enterprise. This concept has become an ESG factor.

ESG factors improve adjusted returns by reducing investment risk and creating value. Each of these factors views the company in a different role. Environmental factors see it as a manager of nature (this includes action against climate change, harmful emissions and greenhouse gases, use of clean water). Social factors show how the company manages its relationships with employees, suppliers, customers, communities, which includes labor standards, health and safety, relationships and more. Corporate governance refers to the qualities of the management of the companies, the remuneration of the managers, audits and internal control, transparency of the management, etc. Accordingly, any well-run and responsible company that cares about people, customers and the environment is more likely to perform better and outperform its competitors who do not. And the analysis of the ESG factors of each company allows investors to make more informed investment decisions. In its current sense, the term ESG was first mentioned in 2004 in a UN report outlining the changes that will take place in the financial sector in the coming years. The designers of this strategy at the time were financial giants such as Britain’s HSBC, Germany’s Allianz and Deutsche Bank, as well as US investment leaders Morgan Stanley and Goldman Sachs. The vision that was built at that time is largely preserved today – of course on a much larger scale.

The Organization for Economic Co-operation and Development (OECD) recently issued a detailed plan with criteria and answers to the question of how someone’s ESG rating can be compiled. For example, social factors may include issues related to health, sustainability in the workplace or even broader societal issues such as human rights or social engagement with societal issues. Poor environmental impact can make a company vulnerable to sanctions or specific legal action, and poor corporate governance can stimulate pay, accounting, board management and regulatory barriers if specific requirements are not met.

    There are standards such as TCFD (Task Force on Climate-Related Financial Disclosures) that help companies systematize possible negatives. For example, energy-intensive industries that do not move to greener practices face rising carbon prices, reputational risks, reduced demand for services and threats from climate and environmental litigation. On the other hand, those who use low-emission energy sources and invest in „green“ technologies will receive better financing conditions, a good reputation and resilience to future fossil fuel and carbon prices. As of mid-2023, every company with more than 250 employees will be required to provide non-financial ESG information or a sustainability report. The whole process will be led by the banks, which are already working on its active implementation.

      The main goal is to completely change the way a company is run.The new corporate thinking will inevitably have a further impact on small and medium-sized businesses.Even if a company’s environmental management seems like a commitment only to the big players, this is not the case – the criteria of the big ones are transferred down the ladder to suppliers and partners.

It changes the nature of the legal services expected by investors and entrepreneurs, helping and assisting in the development of business relations in accordance with the law.ESG-oriented legal services are expected to be provided in the relevant areas, but not only, such as:

  • Sustainable finance with legal assistance regarding new ESG regulations in the financial services sector (e.g., amendments of products documentation, internal procedures, assisting in defining the scope of application of ESG regulation
  • Environmental law including legal assistance aimed at introducing environmentally friendly solutions to clients’ businesses and increased energy and resources efficiency
  • Corporate governance with legal assistance aimed at improvement of the company’s corporate and compliance culture, applying the best practices and standards of responsible business conduct. 

Daniela Golemanova, Attorney – at – Law

                                                         Sofia, Bulgaria

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