Module 2. How to understand and analyse ESG issues - 05min
Framework for ESG issues:
ESG criteria can include both the company’s impact on sustainability (e.g., pollution, use of natural resources, interactions with local communities) as well as how it can be affected by sustainability-related issues (e.g., lack of natural resources, reputational or regulatory risks, employee retention). This is sometimes referred to as double materiality.
Examples of ESG Criteria:
- Environmental: Environmental impacts (carbon footprint, air and water pollution, deforestation), use of natural resources (water energy, natural commodities and green products and services, environmental risk assessment and management)
- Social: Human-capital management and health and safety, external stakeholders
- Governance: Corporate governance and Business ethics preparedness (barriers to bribery and corruption)
E, S, and G issues can expose companies to different types of risks:
- Physical risk e.g., floods affecting a factory
- Liability risk e.g., risks that arise from legal and regulatory action
- Transition risk e.g., risk that arises from action taken to prevent climate change, for example changes in public sentiment towards certain assets raising their cost of capital
- Reputational risk e.g., events that affect the customer’s view of the company
It’s important to remember that ESG factors are as much about opportunities as risks. Redeployment of capital to emerging industries, such as solar or wind, will help create new industrial leaders. Beyond the obvious green markets, however, companies across many sectors enjoy upside opportunities associated with changing environmental and social trends.
When looking at ESG, we need to understand what is material for a company.The levels of ESG risks differ depending on the location of a company and its supply chain. The industry sector that a company is part of (e.g., financials, utilities, mining) will also change the importance of the ESG factors relevant to it. By analysing materiality, we can determine what the most important ESG factors are for a company, depending on its sector, industry, or location.
Sustainability issues follow a path on their journey to becoming material. Furthermore, trigger events can influence how this happens or the speed at which an issue becomes material. – this is called dynamic materiality. An example of this is data security in the United States oil and gas sector which was not considered material until a ransomware attack on an American pipeline in 2021.
How would you classify the risk of the following event:
The 2010 oil spill in the Gulf of Mexico involved British Petroleum (BP). This led to several years of litigation and a settlement of more than US$19 billion. BP’s reputation was severely affected, with its stock price declining by more than half and its credit-default swap rising by more than 100 basis points.
Ecological impact would be material for which type of company?