ESG – a brief history of its development – Part 1

The acronym ESG is short for environmental, social and governance. ESG is a process of quantifying an organisation’s commitment to social and environmental factors. It uses specific metrics related to the intangible assets of an organisation that are applied to tabulate a score of the level of this commitment. That is, a corporate social credit score.

The genesis of ESG lies in the early 1960’s with the publication of the book The Silent Spring which documented the adverse environmental effects caused by the indiscriminate use of pesticides (in particular, DDT). This was the beginning of the environmental movement seeking to make corporations accountable for the detrimental effects of their activities on the environment and human health.

In 1987, the Brundtland Commission of the United Nations – aka World Commission on Environment and Development (WCED) – was convened to help direct the nations of the world towards the goal of sustainable development. It promoted the decoupling of environmental degradation and economic prosperity. In doing so, it introduced and defined the term sustainable development as development “that meets the needs of the present without compromising the ability of future generations to meet their own needs.”

In 1992, the United Nations Environment program (UNEP) issued the Statement of Commitment by Financial Institutions on Sustainable Development which became the original backbone of the UNEP Finance Initiative (UNEP/fi) when it was created in the wake of the Rio Earth Summit in 1992. By signing up to the Statement, financial institutions openly recognized the role of the financial services sector in making our economy and lifestyles sustainable and commit to the integration of environmental and social considerations into all aspects of their operations.

In 1994, John Elkington introduced the concept of The Triple Bottom Line (TBL) as a sustainability framework that balances the company’s social, environmental and economic impact. Its underlying purpose was to help transform the current financial accounting-focused business system to take on a more comprehensive approach in measuring impact and success. TBL was a practical approach to sustainability in that companies needed to adopt socially and environmental responsible behaviours that could be positively balanced with its economic goals.

In 2001 the European Commission presented a paper called Promoting a European framework for Corporate Social Responsibility, derived from social expectations and concerns about the environmental impact of economic activities. This was the first time the concept of corporate social responsibility (CSR) was presented as a distinct strategy. The strategy included the promotion of the concept that enterprises are responsible for their impacts on society with an outline of how those enterprises should meet that responsibility. CSR is however, a business model for individual companies without a common set of criteria for measurement of corporate achievement.

The term ESG was coined in a 2004 milestone report called Who Cares Wins. The report was the result of a joint initiative of financial institutions which had been invited by United Nations Secretary-General Kofi Annan to develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions. 

Twenty financial institutions from 9 countries with total assets under management of over 6 trillion USD participated in developing the report. The initiative was supported by the chief executive officers of the endorsing institutions. The U.N. Global Compact oversaw the collaborative effort that led to this report and the Swiss Government provided the necessary funding. 

The institutions endorsing the report were convinced that, in a more globalised, interconnected and competitive world the way that environmental, social and corporate governance issues are managed is part of companies’ overall management quality needed to compete successfully. 

The presumption was that companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory action or accessing new markets, while at the same time contributing to the sustainable development of the societies in which they operate. Moreover, these issues can have a strong impact on reputation and brands, an increasingly important part of company value. 

The Who Cares Wins report recommended that analysts better incorporate environmental, social and governance (ESG) factors in their research where appropriate and to further develop the necessary investment know-how, models and tools in a creative and thoughtful way. 

At about the same time the UNEP/fi published the Finance Initiative Innovative Financing for Sustainability Report which showed that ESG issues are relevant for financial valuation. This report and the Who Cares Wins report formed the backbone for the launch of the Principles for Responsible Investment (PRI) at the New York Stock Exchange in 2006 and the launch of the Sustainable Stock Exchange Initiative (SSEI) the following year.

The purpose of PRI is to understand the investment implications of ESG factors and to support its international network of investor signatories in incorporating these factors into their investment and ownership decisions.

SSEI is a peer-to-peer learning platform for exploring how exchanges, in collaboration with investors, regulators, and companies, can enhance corporate transparency – and ultimately performance – on ESG issues and encourage sustainable investment.

ESG has come a long way since 2006 with ESG on track to reach US$53 trillion in assets under management (AUM) for 2021. While Europe accounts for half of global ESG assets, the U.S. has the strongest expansion this year and may dominate the category starting in 2022.