Environmental, social, and governance (ESG) criteria are a set of non-financial standards for a company’s operations. They are designed to evaluate the overall operation of an enterprise through different indicators in the areas of environmental, social, and governance. ESG investing ranges from stocks, bonds, funds to different fixed-income assets, both listed companies and enterprises involved. A company with a higher ESG rating means its operations can promote sustainable development and bring positive environmental, social, and economic benefits.
Traditionally, enterprises used to focus solely on returns in operation, while neglecting problems such as environmental pollution, infringement of consumer rights, and exploitation of labour benefits, which brought significant risks and uncertainties to the long-term development of enterprises. Through ESG concepts, investors can evaluate whether a company has achieved a balance in environmental, social, and governance, so as to make better investment decisions.
In summary, there are three elements of ESG criteria in assessing a company's operation:
Environmental: covers energy use management, waste management, climate risk, natural resource scarcity, pollution, waste, etc, related to the environment.
Social: covers labour practices, information security, product liability, risk interests, employee health and safety management, marketing management, data privacy and protection, etc.
Governance: covers issues of corporate governance and conduct, such as board quality and effectiveness, risk management, business ethnics, supply chain management, and etc.
There are many rating systems in the market that refer to the ESG of companies and are introduced by professional organizations. Among them, the Hong Kong Quality Assurance Agency (“HKQAA”) has been appointed by the Hong Kong Hang Seng Index Company to launch the first ESG index on Hong Kong companies since 2010. The HKQAA, as an independent and professional assessment body, uses its dedicated sustainability assessment and a scoring mechanism to assess the ESG performance of about 500 Hong Kong-listed companies. The following is the rating model and the referenced assessment criteria:
| Sustainable | AAA, AA+, AA, AA- |
| Responsive | A+, A, A- |
| Normal | BBB+, BBB, BBB- |
| Minimal | BB+, BB |
| Vulnerable | BB-, B, C, D |
| Corporate Governance | Business ethics, controversial investments, and others |
| Human Rights | Freedom of expression and censorship, human rights abuses, and others |
| Labour Practices | Labour Management Relations, employee health and safety, supply chain-child labour/forced labour, and others |
| Environment | Land use and biodiversity, spills and sewage, operation toxic or non-toxic waste impact of products and services, and others |
| Fair Operating Practices | Anti-competitive practices, bribery and corruption, and others |
| Consumer Issues | Marketing and advertising, production quality and safety, customer relations, and others |
| Community Involvement and Development | Adverse impact on local communities, and others |
As investors pay more and more attention to social and environmental issues, they place priority over companies' ESG performance when constructing investment portfolios. Therefore, companies that have well-integrated ESG into their businesses could grasp more investment opportunities. In addition, incorporating environmental and social elements into corporate governance can better prevent economic losses and risks caused by environmental and social issues, such as natural disasters, financial crises, and strikes. Furthermore, ESG can help companies to stand out their product, service, and brand image and then sharpen their competitive advantage. By contrast, companies with less performing ESG practices may face higher business risks and have less favorable brand image. These practices will harm the company’s relationship with clients and result in difficulties in raising capital. The companies will lose business opportunities in the market, shaking investors’ confidence and finally lowering the company’s brand value.
After learning that green and sustainable development is a hot investment theme that fits his investment appetite, Little Thrifty would like to invest his savings in companies that have integrated ESG into their business. However, he has little knowledge about local enterprises in this regard, he consulted his teacher.
Little Thrifty’s teacher suggested he refers to the ESG ratings of companies that benchmark the companies’ green and sustainable development and ESG performance. Research shows that by identifying, mitigating, or managing key risks, companies with higher ESG ratings have better share price performance and lower cost of capital.
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