What is ESG and why does it matter to my business?

There is consensus among scientists (PDF, 0.5MB), governments, and most business leaders that changes in the way the economy operates are vital to ensure the preservation of the global environment as we know it today – and that it needs to happen now. Every business, large and small, has an essential role to play in the ESG transition. 

Sustainable, green, eco-friendly, low carbon, net zero emissions, responsible investment – the terminology is everywhere, but definitions can differ significantly. For the sake of clarity, we’ll use the expression ESG, which stands for Environmental, Social and Governance factors.

ESG has become a buzzword in the financial industry. Banks, asset managers, insurers and others use their own parameters to take decisions on financing or investing in projects and businesses, taking into account these factors:

E: Environment
Mitigating impacts on climate, land, water, air, plants and animals.

S: Social
Dealing fairly with employees, customers, suppliers, and communities in which businesses operate.

G: Governance
How a business is run, who is responsible for its actions, and how it interacts with all stakeholders.

ESG considerations concern a business’s goals and long-term strategy, its future revenue and profit, but also how it conducts daily operations, from supply channels and distribution policies to sustainable transport use and the energy efficiency of its premises.

And while change may involve some upfront cost, there are also material benefits and opportunities to sustainability. The financial industry faces the expense of obtaining data to assess and report on how their financing and investment activities comply with ESG criteria. However, the process also helps identify the sectors and activities that are likely to be winners and losers as a result of climate change and government measures to curb its impact, improving business decision-making.

That’s why businesses in fields ranging from pharmaceuticals to health electronics manufacturers have come to KPMG for help to become ESG leaders; changing the way they do business and interact with people and natural resources. In Luxembourg, KPMG works with clients from various industries to help ensure their lending policies reinforce sustainability and contribute to positive environmental and social impact 

All businesses interact with other companies, as well as the communities in which they operate, and a wide range of stakeholders including staff, customers and suppliers as well as their own shareholders.

For financial businesses it means making choices about the companies and activities to which they provide financing or investment. Are they responsible for extensive greenhouse gas emissions, or do their activities degrade the environment? Are they taking measures to embrace the transition to renewable energy and minimize extractive processes?

For financial business the first benefit of integrating ESG when selecting activities to which provide financing or investment is to mitigate risks derived from sustainability factors. What is their exposure to fossil fuel and climate change impact? Are they dependent on natural resources? Have they considered people retention and well-being?

Secondly, companies can have a better view on the direct positive contribution they can bring to sustainability factors. Indeed, consumers and investors have more interest in understanding the impact of their activities. By capturing and communicating on this, companies demonstrate long-terms perspectives and how they contribute to more global actions such as mitigating the impact of climate change.

The imperative to reduce global fossil fuel emissions with the aim of reaching carbon net zero (reducing greenhouse gas emissions to a negligible level and/or offsetting them with carbon capture and storage by forests or technological means) by 2050 is a EU objective which many companies have integrated in their objectives  . 

As a member of the EU, Luxembourg is at the forefront of efforts to finance and regulate the transition to a low carbon and more sustainable society. Successive governments have introduced sustainability measures across all sectors of the economy, from incentives for the production of renewable energy to a ban on single-use plastics.

The European Green Deal, a roadmap for an equitable transition to net zero and the decoupling of economic growth from use of natural resources, is already affecting businesses in Europe. It influences their decisions on energy use, packaging, the eventual ban on sale of new petrol- and diesel-powered vehicles – and how these changes will be financed and by whom.

Funding from the EU and from the Luxembourg government is designed to help businesses manage the cost of embracing sustainability. Some financing options are already available in Luxembourg, and more are in the pipeline.

Because change is difficult for human beings, governments such as Luxembourg’s are using a variety of levers and incentives, including subsidies for installing renewable energy equipment, consumption, and for insulation.

Meanwhile, companies will be protected from unfair competition from businesses outside the EU that are not subject to the same rules. The Carbon Border Adjustment Mechanism imposes financial levies on imports of aluminum, cement, fertilizers, electricity, hydrogen, iron, and steel from countries and producers that do not have to meet equivalent environmental obligations.

The EU introduced in 2021 the Sustainable Finance Disclosure Regulation, which requires financial market participants to provide information about the ESG characteristics of investments, sustainable investment and EU Taxonomy aligned investments. The main objective of the SFDR is to increase ESG transparency to investors and facilitate decision-making process.

And from 2024 companies, starting with the largest corporations, must report on impacts, risks and opportunities for material sustainability topics  under the Corporate Sustainability Reporting Directive, which will help financial institutions and stakeholders gather more standardized ESG data, allowing for benchmarks and better decision-making on investments and consumption.

In our next article, we will explore the need for robust ESG reporting. Whether for companies seeking finance and investment, or those whose customers and staff insist they play a role in the global climate transition, sustainability claims need solid supporting evidence. Companies that engage in greenwashing – making themselves look more sustainable than they in fact are – could put their reputation, sales and share price at risk.

Conversely, companies including financial institutions that embrace sustainability, especially regarding climate change but also by upholding fair business and employment practices, stand to benefit, not only in areas such as international standing and recruitment, but also in efficiency, cost savings and alignment of their business models with the evolving global environment.