What is ESG?
The three pillars of ESG are used when measuring the sustainability of an investment. Consideration of each strand should be embedded into investment decisions, with the goal of capturing the non-financial risks and opportunities inherent to an investment. Taking each in turn:
Environmental (E)
The environmental pillar of ESG considers how an organisation impacts the physical environment. Focus is often placed on climate change and reducing greenhouse gas emissions, although examples of other key environmental considerations include: biodiversity loss; renewable energy; energy efficiency; resource depletion; chemical pollution; waste management; depletion of fresh water; ocean acidification; stratospheric ozone depletion; changes in land use; and nitrogen and phosphorus cycles.
Social (S)
The social pillar refers to an organisation’s relationships with all of its stakeholders, including employees, customers and community at large. Examples of social considerations include: activities in conflict zones; distribution of fair trade products; health and access to medicine; workplace health safety and quality; labour standards in the supply chain; child labour; slavery; relations with local communities; human capital management; employee relations; diversity within workforces; controversial weapons and freedom of association.
Governance (G)
Governance is the system by which organisations are directed and controlled. It deals largely with the structures and mechanisms in place between the constituent parts of an organisation’s operations, for example: the directors; the board (and its sub-committees); and the shareholders. Governance issues may include: executive benefits and compensation; bribery and corruption; shareholder rights; business ethics; board diversity; board structure; director independence; risk management; whistle-blowing schemes; stakeholder dialogue; lobbying and disclosure. Transparency and accountability are key to good corporate governance, which includes: the provision of good quality information in a timely manner; and documenting clear and credible decision-making processes. Governance may also include the implications an organisation’s strategy has on environmental and social issues, and how the strategy is implemented.
NILGOSC believes that these factors should be taken into account when managing the Scheme’s assets, subject to its overriding fiduciary duty to maximise the financial return on investments. NILGOSC has developed a Statement of Responsible Investment to outline how such issues are incorporated into its investment practices. As a means of demonstrating its commitment to responsible investment practices, NILGOSC has adopted the United Nations supported Principles for Responsible Investment (PRI) and exercises its vote at all company meetings in which it has a shareholding as a means of expressing concern over ESG issues. NILGOSC also engages with companies: directly, by issuing engagement letters to UK and other European listed companies in its actively managed equity portfolios; in collaboration with other investors through collaborative engagements; and indirectly, via its Investment Managers. NILGOSC seeks to improve corporate behaviour and protect shareholder value by maintaining effective shareholder oversight.
Responsible Investment
Responsible Investment (RI) is about recognising that the impacts of organisations on the environment, their supply chains and on communities can seriously affect the value of investments in those entities. RI also places a high value on organisations’ own good governance.
NILGOSC believes that ESG issues affect the performance of investments. Examples of how an organisation’s ESG practices can have a financial impact may be where poor environmental performance results in compensation claims and/or costly clean-up measures, or where exploitative labour practices may affect a company’s brand, reputation, worker productivity and ultimately its share value.
Responsible investment differs from ethical investment, which generally focuses on excluding or including companies from an investment portfolio (“positive or negative screening”). RI, by contrast, involves investors using their shareholder power to influence the companies they invest in. NILGOSC does this by voting at shareholder meetings and by engaging, both directly and indirectly, with company senior management when ESG issues of concern are identified. The purpose of voting and engagement is to improve corporate behaviour and to protect shareholder value.