Environmental - the 'E' in ESG

The assessment of how a company interacts with its environment is one of the three key factors in understanding ESG risks and opportunities. This is the ‘E’ in ESG.

Fundamentally a measure of a company’s impact on the natural or physical environment, this could be related to use of natural resources, policies on business travel or how it reduces waste in its operations, for example.

Climate change is perhaps the most significant of challenges facing humanity, and therefore one of the most important elements in assessing ESG factors; this is because of the likely impact that climate change will have on every aspect of our lives but also because of the regulatory and societal changes that will be required to combat it. Planning for and reacting to these changes will mean that companies will either be able to thrive or will struggle as world governments make the necessary policy changes.

Therefore how a company contributes to greenhouse gas emissions, its carbon footprint, its use of resources, its waste policies and its energy needs are all important to understand. Companies that do not consider the impact of their businesses on the environment are also leaving themselves open to regulatory sanctions, criminal prosecution and reputational damage, which will all have an effect on the balance sheet and therefore shareholder value of the company.

It is also believed that the current markets have not priced in the inevitable changes to governmental policies that will take place as the realities of climate change become apparent. This will mean that we will see tangible financial impacts to companies that are not prepared to move with the decisive changes likely to take place.

Climate change is also likely to result in more frequent and more damaging meteorological events, resulting in the risk of significant financial losses which will need to be factored in to any assessment of a company.

Aside from the various impacts of climate change, there are a number of other factors that are important to understand. The transition to a circular economy, eliminating waste and making continual use of resources, is likely to be painful and necessary. Therefore how a company makes use of resources and how they deal with waste is a key factor.

Finally, energy considerations are far reaching and impactful; use of sustainable energy, reduction of fossil fuel usage and reduction of carbon footprint are also part of the assessment of ESG factors.

A company that is placed to make efficient use of resources, cope with regulatory change and take advantage of opportunities as society inevitably reacts to changes in the natural world will be at less risk to shareholder value than companies who risk sanctions, reputational damage and loss of earnings as a result of short-sightedness of environmental impacts or interact with their environment recklessly or in a damaging manner.