Insights

What ESG is and what it is not

Increasingly becoming the flavour of the month in business circles and topping the agenda at most conferences, ESG is quite often misrepresented as a synonym for Corporate Social Responsibility (CSR) or a polite way of reminding us that we should print less and recycle more. But ESG is far greater than that and the purpose of this article is to shed some light on what ESG means in practical terms for Maltese issuers.

However, in order for one to understand the legal implications (of which there are several) of ESG, one must first understand what ESG is all about and, more importantly, what it tries to achieve, as it is only when one appreciates what ESG is that one can really begin to appreciate what its impact could be.

‘ESG’ is an acronym for ‘Environmental, Social and Governance’ and is generally used as an adjective to describe factors related to the way companies operate, which factors are increasingly becoming the main focus of investors and regulators alike. So called ‘ESG factors’ (which place added focus on matters such as climate change, proper working conditions and enhanced diversity on corporate boards) are, however, not just empty buzzwords, but are a means of reaching a desired end – more sustainable companies and resilient economies which can withstand shocks that will inevitably come their way. Perhaps there is no better illustration of the importance of achieving a more sustainable economy than the COVID-19 pandemic which has clearly shown that everything is connected to everything else, and that the stakes with continued unsustainability are high, because in an ever-connected world, the failure of one part of the economy can send devastating shockwaves throughout the entire system.

The European Union’s (EU) commitment to sustainability traces its roots to the EU Treaties. Sustainability is an overarching objective of the EU and meant to be the guiding principle for the EU’s policies and activities within Europe and in its relations with the rest of the world, to promote “peace, its values and the wellbeing of its peoples”, Treaty on the European Union (TEU), article 3(1). The values are set out in article 2 TEU: “respect for human dignity, freedom, democracy, equality, the rule of law and respect for human rights, including the rights of persons belonging to minorities”.

This said, it is amply clear that traditional approaches to encouraging corporate sustainability, such as self-regulation based on CSR or corporate stewardship codes, have yet to deliver sufficient improvements in, for example, human rights protections or mitigation of climate change, despite decades of attempts to do so.

Due to these shortcomings, and in light of the realisation that “it’s one minute to midnight on that Doomsday clock”, we are (finally) witnessing a paradigm shift in focus in global markets. Investors are increasingly shying away from investing in firms which merely aim to maximise their returns, without paying any attention to their impact on the environment and people’s lives, and are instead investing in firms whose business models are designed to be more sustainable – by properly regarding ESG factors and considerations in the course of their activities. Environmental considerations include climate change mitigation and adaptation, as well as the environment more broadly, for instance the preservation of biodiversity, pollution prevention and the circular economy. Social considerations refer to issues of inequality, inclusiveness, labour relations, investment in human capital and communities, as well as human rights issues. Governance considerations include proper management structures, employee relations and executive remuneration.

ESG therefore is not an off-shoot of CSR, or merely a synonym of “going green”. Rather it is a cultural shift away from the social norm of ‘shareholder primacy’, where directors are regarded as the ‘agents’ of shareholders and should maximise returns to shareholders, which norm is evidently not conducive to creating a sustainable economy. Rather, ESG signifies a cultural shift which rewards companies who pay due regard to environmental, social and governance issues in the conduct of their activities and shareholders are one of the main drivers of change – in fact, they are increasingly voting in favour of sustainable initiatives and are increasingly requesting ESG-related factors to be placed on AGM agendas.

This article was first published in The Times of Malta on 6 December 2021. It is the first of a two-part series. The second article will focus on the current ESG regulatory framework for listed companies, and will also provide a number of practical tips which issuers can implement in the short-term.

The author would like to thank Luke Hili and Andrea Grima for their help in drafting this article.