Understanding what ESG stands for organization
ESG stands for Environmental, Social, and Governance. You must have read about this in the Annual Reports of various organizations. Today let’s try to understand this topic called ESG in three sections: One, What it stands for and how it is essential for companies. Two, Why it is crucial for Finance (especially now) other industries like eCommerce & Retail, how the “big data companies" are taking a stand for it, with examples that caught our attention wrt the ESG space. Three, how technology is helping companies in their ESG goals.
Let’s keep it short. ESG reports that companies talk about the Environmental, Social, and Governance impacts. Let’s break down the three components in it:
1. Environment: Every company uses resources and energy for its operations. This “E” is about how much energy the companies take in and how much it discharges. It can be wrt carbon emissions, climate change, etc. All the jargon about carbon neutral, carbon positive, etc. would fall into this category.
2. Social: This is about the relationship of the company with the people and institutions. Companies' efforts for Diversity & Inclusion, Labour Relations, Education, etc. would fall under this category.
3. Governance: This is more related to the internal procedures, processes, and practices the organization adopts to comply with the law and meet the needs of stakeholders.
Two of these three components, namely Social and Governance are what the majority of the companies try to highlight for reasons that can be quite easy to understand i.e. they need not need major changes to the infrastructure. So today wrt ESG we will be talking more about the Environment part, as the change needed for this is larger than the others.
Bloomberg reports that the Environmental, Social, and Governance (ESG) assets are on track to exceed $50 trillion by 2025. And it is fundamentally reshaping financial reporting. Markets have become sensitive to ESG news, more scrutiny from regulators is being seen, and the ESG tags. Higher ESG ratings are generally positively correlated with valuation and profitability while negatively correlated with volatility.
You can see the global projections for ESG in the picture below (Values in Trillion dollars). In India, the ESG funds can be called to be in their infancy phase which approximates 12,300 crores (~ 0.0016 trillion dollars) in comparison to $17 trillion in Europe.
In reporting, true transparency is no longer about the numbers or financial reporting only, but also extends to ethical and sustainable business practices. ESG’s goal is to kickstart the activities of making the investors understand the underlying philosophy of the consumers.
In India, there is a lot of scope for development and growth in this space, especially compared to world standards. For example, for Insurance Industry take a look at the image below:
The image above shows how the world’s largest insurers are already rated much better than listed Indian insurers, who sport a medium-to-low ESG risk rating but haven’t disclosed their decarbonization targets. Nor any details on how they are going to cut their carbon footprint annually.
Understanding how specific changes would affect Industries
Did you know that the cardboard boxes, bubble wrap, and packaging, cost Amazon India $1 billion in fulfillment costs? Globally, though Amazon is committed to Shipment Zero, a 2020 report from nonprofit ocean advocacy organization Oceana estimates that Amazon was responsible for 465 million pounds of plastic packaging waste in 2019 globally. What would ESG mean for such organizations?
It would mean a decrease in the use of single-use plastics such as bubble wraps, plastic wraps, and air pillows from fulfillment centers. It can also involve replacing plastic with paper but this would require increasing its spending by 2.5x.
Retail & FMCG
Single-use plastics form a major part of Juice and Beverage giants in FMCG and Retail. The Indian Government has planned to ban the same from 1st July of 2022 in an effort to reduce the consumption of plastic and reduce its effect on the environment. But how would it affect the companies? It would result in an increase in cost, for example, a plastic straw costs 10 paise for a 10rs juice box, whereas a paper straw in comparison would cost around 40-45 paise resulting in an increase of 30-35% cost for the final good. For the beverage manufacturers, this would mean a loss of 3000 crore rs.
Research shows that every Google search releases roughly 0.2 grams of CO2 emissions, and with 3.5 billion searches a day it amounts to ~ 40% of the internet’s carbon footprint. This is just an example, even other platforms like Facebook, Websites, and everything that can be called a “cloud” occupies some physical space and would result in some CO2, but the calculation becomes trickier. Why are we talking about Google?
Because they have been offsetting their emissions, bringing locally sourced carbon-free energy, and announcing features to help people make more sustainable choices.
How is technology transforming ESG
Before we go into the use of technology and how it is transforming the ESG space, it is important to understand how granular data aids and assists the same. ESG ratings that are given by third-party providers are normally considered the benchmark for investors. But now, they want to look at the sources of the data and the granularity. This might include:/
- Scope and Location-based data
- Carbon reduction targets
- Workforce categorization
- Changes in the company board, etc.
Data Quality becomes important for managing such data and to be analyzed by Data Analysts and ESG Specialists. In addition to this, the Qualitative Data is also being analyzed to check the occurrence of instances of words like “ESG”, “Environment”, “Governance”, etc., or even sentences to determine the tone, repeat count, etc. that can be measured and compared across various reports too. This is why Data Quality, Governance, and Analysis are also required for ESG reporting and maintenance.
In addition, technology is helping with the ESG cause in the following ways:
- Green software development techniques to reduce energy consumption by 50%
- AI Bias reduction in hiring algorithms to promote more diversity and inclusion
- Improving Data trust, by employing NLP techniques (like sentiment analysis) on stakeholder perceptions
- Blockchain to improve transparency in ESG Data collection and reporting
- Impact Reporting at the portfolio level for Finance
- Combining the data across the supply chain to get accurate reporting
What do you think about how technology can help with the entire ESG ecosystem? Do share your thoughts!