Much is said about ESG without ever defining ESG. In the now-politicized discussion, it seems everyone has an opinion, but fewer have an understanding.
In this blog series, we will also be saying a lot about ESG, so first, in the interest of developing actionable insights, let us define ESG and a few corollary points:
- Performance: ESG is performance data abstracted from the interplay of corporate operations in relation to market dynamics, environmental realities, and reflexive social landscapes. Fundamentally, ESG is about identifying environmental, social, and governance issues which are material to corporate performance either directly or indirectly by being material to the markets within which the corporation operates or seeks to operate, and monitoring and measuring organizational positioning and operational performance along these vectors.
- Risk Management: ESG is extra-financial information material to the investment decision-making process that can help protect value and, under specific circumstances, create value. ESG performance can be aligned with longer-term business development objectives; however, it should be noted that in the vast majority of cases poor ESG performance is a greater threat to established value than good ESG performance is to creating value. For most middle market and lower PE firms and their portfolio companies, ESG is best suited as a risk-management framework rather than a strategic development trajectory.
- Compliance: ESG is growing fastest as a form of compliance, and this will continue over the near- and medium-terms. The ESG landscape is growing top-down, resulting in most middle market and lower PE firms and their portfolio companies shaping their ESG activities and reporting to comply with the requests and interests of other actors within the financial value-chain. Emergent regulations, particularly in the EU but also UK, USA, and soon in Australia and Canada, are pushing the largest institutional investors and asset managers as well as the largest corporations to enhance their disclosure of, and accountability for, ESG issues across their portfolios and supply-chains, respectively. These entities, in turn, transform these regulatory mandates into powerful market dynamics incentivizing compliance–understanding these dynamics can readily simplify ESG programs and reporting for most middle market and lower PE firms and their portfolio companies.
- Materiality: ESG is a universe of data and not an agenda. There are plenty of activist stakeholders and commentators with normative views as to what ‘good’ ESG should be. These voices have gained traction in popular press and commentary but not in the actual practice of ESG. There is no inherent agenda to ESG in practice, rather the foundational concept of financial materiality persists. Actionable ESG insights are drawn from a focus on materiality and supported by appropriate data. An ESG topic is only material to a company if it can reasonably and demonstrably by anticipated to impact company operations and/or market outcomes directly or within one degree of separation over a near-term timeline. What is material to one may not be material to another, and the difference will be made clear in the data rather than some normative agenda.
These are core positions we hold at Motive. I am less concerned with trying to get you to agree explicitly with me than I am in trying to make sure you understand where we stand when we are discussing ESG. When we review new ESG regulations and discuss the implications of these for PE firms or when we work with a portfolio company in responding to an ESG request by a client, we start from these positions.
Although less politicized now than even just six months ago, ESG is likely to remain a relatively vague term drawing more commentary than it truly deserves. The least we can do when discussing ESG is make sure we start from first principles.