As the world acknowledges the challenges of climate change and aims to address them by reducing greenhouse gas emissions, the concept of environment, social, and governance (ESG) has gained significant traction in the corporate and investment world.
It represents a framework that integrates environmental, social, and governance factors into business strategies, aiming to drive long-term value creation while promoting sustainable development. Such investors aim to buy shares of multinational companies whose performance in the mentioned genres has improved.
These three criteria are used to evaluate companies for ESG investments.
For instance, as far as the environment is concerned, examining the kind of impact a company makes on the environment. Businesses are increasingly recognizing the need to mitigate climate change, conserve natural resources, and minimize their carbon footprint.
By adopting sustainable practices such as reducing carbon emissions, implementing renewable energy solutions, and practicing efficient waste management, companies can contribute to environmental preservation and reduce climate change risks.
Why is ESG critical?
ESG investing began in the 1960s; however, the term was coined in 2004 by former Secretary-General Kofi Anan.
Nevertheless, the ever-increasing pace of growth attracts investors as more and more look to incorporate ESG factors into the investment process. Numerous studies have demonstrated a positive correlation between strong ESG performance and long-term financial outperformance. By integrating sustainability considerations into their projects and operations, companies can improve risk management.
Additionally, it enhances operational efficiency and maximizes the opportunities that arise as the economy transitions to a low-carbon one. Consequently, making investors acknowledge the importance of ESG factors and molding their investment decisions.
Furthermore, the surge in its popularity has forced investors to align their portfolios with their values. The process involves selecting companies that exhibit strong ESG practices and avoiding those associated with environmental damage, human rights violations, or hampering governance.
This shift in investment preferences has prompted companies to improve their ESG performance to attract capital and gain a competitive advantage, vis-à-vis starting a chain of actions.
Anticipatedly, ESG considerations are now being integrated into investment strategies, influencing capital flows and thereby shaping corporate behavior.
Challenges to ESG
ESG, along with net-zero carbon practices, has moved the business agenda. emphasizing the collective goal of the Paris Agreement 2015, to ‘decrease the global average temperature to well below 2 degrees Celsius above pre-industrial levels as well as limit the temperature increase to 1.5 degrees Celsius above pre-industrial levels.’
What role do stranded assets have to play?
Stranded assets can be defined as assets that have experienced an anticipated or premature devaluation due to the impact of several changes, ranging from environmental changes and new government policies to evolved social norms.
In addition, typically it arises from the emerging need to be more sustainable, for instance, fossil fuel reserves; due to the transition to renewable sources of energy and incompatibility of fossil fuel with the low-carbon economy, such as coal and oil are at high risk of becoming stranded.
Interestingly, factors that cause stranded assets consider changes in consumer behavior as well as technological costs.
Furthermore, various studies have demonstrated that ESG challenges which are primarily driven by the climate change have a profound impact on the banking sector. As their role as financial intermediaries and capital raising agents.
Therefore, it’s crucial for banks to encourage sustainable business practices. However, banks alone cannot be acting as a harbinger of sustainable business practices, hence an interdisciplinary approach is required.
For instance, banks suffer financial risk due to insurance companies excluding claims related to environmental damage.
Since the 1980s, climate-related incidents and losses have multiplied, resulting in liability risk exposure due to corporate mismanagement of climate risks and operations have consequently resulted in increasing claims.
On the other hand, even asset management faces a slump in policymaking due to corporate mismanagement and greater financial risks.
Therefore, when the arising conflict is interdependent, the forthcoming solutions have to be a joint effort of all the involved sectors.