ESG is an acronym much used but perhaps less understood. Externally, with particular reference to the “E” and the “S”, it describes a range of impacts that a company or business has on both people and the planet. The “G” describes the internal workings of a corporate entity and the extent to which the mechanisms, systems and structures implemented by those in senior positions within a company create a culture that enables that company to meet its business, environmental and societal goals.

What is ESG?

ESG stands for Environmental, Social and Governance and represents a framework for assessing the relationship between (i) a company’s culture and sustainable and ethical practices, (ii) its financial performance, and (iii) its investors and, critically, other stakeholders.

In recent times, there has been a shift in the utilisation of this ESG framework. Previously just a tool for impact-conscious investors to identify suitable investments, with increased government attention and regulation, companies are now under pressure to report on their ESG credentials. Greater transparency through corporate reporting is focussing attention on how ESG factors are incorporated into a company’s business model, core operations and risk framework. This has gone hand in hand with a shift in attitude. Companies are now expected to carry on their business with a serious regard to the long-term interests of all their stakeholders (i.e. not just shareholders/investors). A company’s impact on (i) its wider stakeholders and (ii) more broadly, society and the environment – its “ESG footprint” – is no longer viewed as an issue of ethics alone, but as critical to corporate performance and sustainability.

Breaking Down ESG?

The “E” – Environmental – focusses on a company’s impact on the environment and its ability to mitigate risks of environmental harm. Common points of reference include a company’s:

  • use of energy;
  • carbon emissions and carbon footprint;
  • water generation and levels of pollution produced;
  • utilization of resources;
  • packaging material & waste; and
  • treatment of animals.

The “S” – Social – considers how a company’s operations and policies impact on its workforce, on communities, on other businesses andsociety as a whole. It assesses a company’s performance on key issues such as:

  • gender and diversity;
  • human rights;
  • labour standards and management;
  • health and safety;
  • data protection and privacy; and
  • consumer protection.

The “G” – Governance – examines a company’s internal affairs and the relationship between the key stakeholders. It incorporates corporate governance and behaviour issues including:

  • culture within the company;
  • board composition and diversity;
  • executive compensation;
  • anti-competitive practices;
  • accounting policies;
  • lobbying;
  • tax transparency;
  • reporting transparency;
  • bribery and corruption; and
  • whistle-blower schemes.

Though often used synonymously, it should be noted that ESG is a distinct concept from both (i) impact investing; and (ii) Socially Responsible Investing (SRI). Impact investing seeks to generate specific beneficial social or environmental effects first, with financial gain a secondary (but important) objective. SRI is a screening method used to exclude certain potential investments from portfolios.

In contrast, ESG is a lens through which to view an organisation (whether viewed from inside or outside the organisation) and thus either for the board to direct policies and actions or for investors to make an appropriate choice – but with (i) financial return, (ii) identifying value, and (iii) limiting undesired risk still at the forefront of the decision making process.


While ESG is now the hot topic on the regulatory and business agenda, it has deeper roots than might first appear and its development has been shaped by a series of interrelated events over the past decade. Below are a selection of key moments in the chronology and development of ESG.

Roots of Governance

ESG – in the UK at least – has its roots in corporate governance, including the work instigated by Jonathan Charkham at the Bank of England during the early 90s. During this period, a fundamental connection between the UK’s underperformance against major competitors (Germany, Japan and France) and an insufficient UK corporate governance system was made. From this came crucial developments such as (i) an increased focus on removing institutional shareholder passivity; (ii) the “PRO NED” campaign; and (iii) the Cadbury Report – produced by Sir Adrian Cadbury – which highlighted the need for reform of (amongst other things) (a) the selection of non-executive directors; (b) the determination of executive remuneration; (c) narrative reporting; and (d) financial reporting.

While Charkham set the ball rolling on governance, it continues to be developed and refined (and - sometimes - simply redefined). Section 172 statements came out of the more recent focus on companies’ purpose in relation to, in particular, their wider stakeholders and impact vs ‘shareholder primacy’. The rules require companies that fall within the regime to include a separate statement in their strategic reports explaining how their directors have had regard to wider stakeholder needs when performing their duties under s.172 Companies Act 2006.

Global Financial Crisis

The Global Financial Crisis represented a watershed moment for ESG. It shone a spotlight on banks’ failures of governance and culture, prompting loud calls, both from government and the public, for financial market actors to review their capital allocation and investment policies. An expectation arose that investment should be aimed at solving social and environmental issues – while also implementing more stringent governance to oversee the activities of financial market participants.

The United Nations Sustainable Development Goals (SDGs)

The UN adopted 17 Sustainable Development Goals in September 2015 (SDGs). The SDGs relate to poverty, inequality, climate change, environmental degradation, peace and justice. The UN’s aim is to achieve these goals by 2030.

Paris Climate Conference

Held in December 2015 and seeking to build upon the UN Framework Convention on Climate Change, the conference’s fundamental aims were to (i) strengthen the global response to the threat of climate change; and (ii) strengthen the ability of countries to deal with the impacts of climate change. On the back of the conference, 170 nations signed up to the COP21 Agreement, which set a goal of limiting the average global temperature rise to 2 degrees Celsius above pre-industrial levels. It put pressure on governments to meet their respective goals. As such, subsequent legislation has put further pressure on investors to align investment strategies with these aims. Accordingly, many investors have responded by overweighting their portfolios with companies either on a credible decarbonisation path or offering green solutions.

European Action Plan on Sustainable Finance

In March 2018, the European Commission unveiled its Action Plan on Sustainable Finance. The plan includes various proposals to drive sustainability in the EU, including by developing low-carbon benchmarks and a comprehensive classification system for investors to identify environmentally sustainable economic activities. This has been supported by EU legislative activity aimed at integrating ESG risks into investment and advisory processes and communicating the positive impact that ESG integration can have on returns and profitability.

New Generation of Investors

By 2025, it is expected that millennials will make up 75% of the workforce and will adopt the pension, investment and wider spending power that accompanies this position. This generation is at the forefront (and has an unparalleled awareness) of the discourse around issues such as the climate emergency, scrutiny of companies’ practices, consumer ethics, and diversity – all key ESG issues.

Put simply (while of course not all will prioritise social returns, preferring a more traditional investment policy), by and large the new generation of millennial investors wants to ensure its investments have a positive impact on the world, beyond pure financial gain, and increasingly expects this aspect to be built into the system on a fundamental level, rather than as an optional extra.

The corporate sector – and specifically asset/investment managers – are adapting to their new, younger audience/market and the consideration of ESG factors is now a pre-requisite.

Implementing ESG

ESG v Financial Performance

In a previous era, corporate boards were often focussed on short-term market share and share price objectives and directors’ incentives and remuneration were linked to these short-term goals. The upshot is that many directors were forced into a difficult and conflicting position in relation to the running of their businesses. Even where institutional and activist shareholders did take a longer-term view and looked for sustainable business practices from their portfolio companies to alleviate the reputational risk of being associated with businesses with poor ethics and negative impact, there was still the perception that pursuing a more sustainable long-term strategy might result in reduced short-term financial gain. Directors may have struggled to provide the returns/ profits to their shareholders in the short term that were previously accessible. This in turn could damage the personal commercial reputation of a director, and negatively impact on salary and prospects. In short, though the concept of working within an “ESG-friendly” framework was generally agreed as preferable, it was arguably often over-looked due to short-termism at both board and shareholder level.

This perception is changing. For example, in November 2020, Edelman released their 2020 Edelman Trust Barometer Special Report, which surveyed 600 institutional investors across six global markets representing $20 trillion in assets under management. The study uncovered the following current fundamental investor attitudes:

  • Investors agree that profitable companies have a greater responsibility to address ESG issues than companies that are struggling;
  • The large majority of investors agree that companies that prioritize ESG initiatives represent better opportunities for long-term returns than those that do not;
  • Companies that excel in ESG merit a premium valuation;
  • Diversity and inclusion (D&I) disclosures impact investor trust and share price – which is reflective of a general trend that “social” issues have taken priority during the pandemic;
  • Investors want executive remuneration tied to ESG performance; and
  • Investors (i) are more prone to take an activist approach in the running of their respective portfolio companies; and (ii) will also take a greater interest in the supply chains related to their portfolio companies (which re-iterates a key theme of this piece – the focus, at all levels, on the wider stakeholder community).

Furthermore, recent data have shown that failure to prioritise ESG factors can actually have significant negative financial ramifications for companies. Volkswagen’s emissions scandal ultimately cost the company some $12 billion.

In addition, 2020 was arguably a year of outperformance by ESG companies. Data from the Investment Association shows that £7.1bn was invested into ESG UK funds over the first three quarters of 2020, compared to £1.9bn in 2019. As a specific example, Scottish Widows announced in November 2020 that it would divest c.£500bn from companies that failed to meet its new environmental, social and governance standards in an effort to protect investors from ESG investment risks.

This switch in attitude will relieve the pressure on directors to meet short-term targets and therefore enable them to implement key ESG principles (that can take time to embed into a company’s culture). This is happening parallel to a continuing consideration and development of remuneration policy and incentive structures, and how best to align them to longer term sustainable goals.


“Culture” is a key element to this topic – particularly in relation to the financial services (FS) sector, but also generally in relation to embedding an organisation’s approach to ESG that is more than paying lip service to investors and commentators. However, for the FS sector, the view that failings in culture contributed to the financial crisis has pushed the FCA and legislators to introduce new regimes and focus part of their oversight of firms in order to ‘improve’ the internal culture of businesses within the FS sector. Regulators (including the FCA, the Banking Standards Board and the Financial Reporting Council) are hoping, by introducing such initiatives, both to (i) address the recent major conduct failings, economic downturn and range of scandals that have impaired trust in the FS sector; and (ii) demonstrate that healthy cultures can also complement and support businesses’ financial performance.


Linked to “culture” is the increased focus upon narrative reporting. The benefits of thorough narrative reporting are clear. Effective narrative reporting will give investors and stakeholders clearer and deeper insights into what fundamentally drives the value in a business, thus increasing both the level of investor trust and the reputation of the business (which in turn increases the company’s market rating and ability to attract and retain the best talent).

The twin issues of standardisation and transparency in ESG data and reporting are illustrative of the challenges that remain in moving towards an effective ESG culture. The lack of a standardised industry framework for ESG measurement and reporting is a major roadblock to meaningful implementation of sustainability policies, as well as effective enforcement. Without consistent and comparable data, subjectivity reigns, which opens the door to inevitable ‘greenwashing’ behaviour and a lack of trust over just how ‘real’ these commitments are.

Key Parties, Initiatives and Regulation

It can feel like there is seldom a code, piece of corporate legislation or regulation introduced that is not connected to ESG. The Appendix provides a high-level summary of the some key regulations, codes and organisations that play a fundamental role in incorporating ESG into a company’s operations.

What next for ESG?

ESG is a rapidly evolving area, with change being driven by pressure from both investors and regulators, with the shifting demands of the former paving the way for the attentions of the latter.


There is a marked trend among investors to incorporate non-financial data into their portfolios alongside financial data. This is in part a response to a skyrocketing interest in ESG investing, and the principles and concerns it represents, among a far more socially-conscious millennial generation that is now inheriting existing pools of wealth en masse.

On top of this generational shift in priorities, there has also been a marked shift in attitudes among asset managers themselves in terms of the relationship between these forms of investment and the core traditional task of generating returns. A consensus is rapidly forming that ESG and impact investing not only represent a new priority for their clients, but also represent the most reliable means of generating returns in the future.


Legislators and regulators in all key jurisdictions are reviewing how to accommodate this shift and ensure that companies and funds build sustainability into their products and investment strategies on a consistent and fundamental basis.


The implementation of the various elements of the European Commission’s Action Plan on Sustainable Finance will continue to drive change to, and focus on, sustainable investment together with the wider legislative agenda to, for example, harmonise and improve reporting.


While the departure of the UK from the European Union necessarily puts the regime on a different track to its European neighbours, the stated intentions and direction of travel on this issue are very much alike.

The UK has some of the most ambitious climate change targets of any regime globally – most notably achieving net zero emissions by 2050. This can only be achieved through widespread compliance across the public and private sector and there is a current and continuing focus on environmental factors in particular.

That said, the pandemic has further highlighted social issues, and the FCA’s focus on ‘culture’ within firms will continue. Following the onset of the Covid-19 pandemic the FCA has understandably focused in on the effects of the crisis on working patterns and priorities, and the extent to which these changes can feed into a sustainability agenda.


Historically, Europe has lead the way in sustainable finance – but this is shifting. Even Asia, known to be significantly behind Europe and the US in ESG investing (data have shown Europe and North America account for more than 90% of the ESG market), has seen multiple jurisdictions adopting ESG disclosure regulations. A symbolic example of this trend was the Japanese Government Pension Investment Fund signing the Principles for Responsible Investment in 2015.


The major point to note in regards to the US is its re-joining of the Paris Agreement following the recent election of Joe Biden. This carries a number of direct consequences for ESG investment and its inclusion amongst his initial executive orders highlights its importance to the Biden White House. Re-joining the accord, combined with advancements in the development of global standardised ESG metrics, will provide far more of an incentive and framework structure for US investors to navigate the shift to sustainability.


Plainly, survival and a return to growth will be a priority for companies and their boards as the world emerges from the pandemic, but all indications are that Covid-19 has enhanced, not diminished, the importance of ESG to corporate success.. The general consensus is that sustainability (in all its forms) will be a central plank to the recovery process, and that companies will aim to build back better and greener.

Covid-19’s impact on ESG

The impact on the “E” of the pandemic is difficult to judge. On the one hand, policymakers are often short-termist in their actions and as such, governments have been slow to pivot towards a greener recovery. The energy crisis, driven by a drop in demand for fossil fuels during the global lockdown, has seen initial governmental support for carbon-intensive sectors; for example, Canada provided tax relief for those operating in Alberta’s oil sands. On the other hand, the widespread and protracted economic downtown will provide an opportunity for policymakers to take a more interventionist approach and link bailout support and stimulus packages to “green” standards. By way of examples:

  • 25% of both the EU’s (i) €1 trillion budget proposal; and (ii) 7-year €750 billion recovery fund to help the bloc recover from the pandemic will be set aside for climate action;
  • a number of national governments’ aviation industry bailouts throughout the last year have been conditional on compliance with sustainability targets; and
  • support for the car industry has been focussed on increased subsidies for electric and hybrid vehicles.

As noted above, from a domestic lens, the UK was the first major world economy to set a net zero target (for greenhouse gas emissions) by 2050. This ambitious target will only be reached if both public and private sector organisations are compliant. Further, in November 2020 Rishi Sunak announced that Britain will issue its first “green government bond” during 2021 to capitalise on the growing investor demands for assets that fund environmentally friendly projects (UK Green Bond). This is not a ground-breaking initiative. During 2019, $250bn of green bonds were sold (which amounted to c.3.5% of bond issuance globally). In 2020, ESG bond volumes reached a record high of $489 billion. Sunak affirmed his commitment to UK Green Bonds in the March Budget by announcing that the government will offer a green retail savings product through the Treausry-backed National Savings & Investments during the summer of 2021.This “Green gilt” issuance for the financial year will total a minimum of £15 billion.

The government’s attitude – encapsulated by Sunak’s UK Green Bonds - reflects the fact that both asset managers and pension funds have large mandates to purchase ESG assets.

Furthermore, companies, from an internal perspective, are also having a rethink. Business travel represents a good example. As a result of the inability to travel for business due to the pandemic, the majority of companies have been forced to conduct multi-jurisdictional business online and ensure that their business is not materially impacted by the inability to meet business partners based overseas in person.

Regarding the “S” – the pandemic has provided some much-needed impetus. PRI conducted a survey of their 3,000 signatories (representing over US$100 trillion in AUM) on ESG and Covid-19 and included questions on social issues, climate change, stewardship, emerging markets and recovery. One eye-catching finding was that 64% of respondents noted that Covid-19 has brought social issues – such as occupational health and safety, worker protection, responsible purchasing practices and supply chain issues, diversity and digital rights (including privacy) – onto their radar, having previously not been a priority.

However, Covid-19 has also shone a light upon the fragility of global supply chains and has had a negative impact on the issues that legislation on modern slavery has sought to address. Due to the pandemic, supply chains have been significantly disrupted (due to a collapse in demand for certain services and products) and thus a large number of workers have lost their jobs and been forced to look for opportunities in “informal economies” – typically rife with exploitation. On the other hand, in certain sectors there has been an exponential boom in supply and demand (related to the pandemic) – the production of PPE representing a prime example. This has tempted businesses to exploit vulnerable workers to either (i) work through the pandemic and thus put them at risk of contracting the virus; or (ii) endure working hours - to meet the huge demand – which are unacceptable.

A continuing hurdle for social issues will be the difficulty to translate such social issues into a quantifiable number in order to understand and register the impact any given company is actually having. For example, how can one compare a business set up in Indonesia that allows women to feed their children with an initiative to tackle youth unemployment in the UK? Each region, country, city and neighbourhood has its own social priorities – unlike the environmental targets that are more global in their nature, i.e. reducing the corporate carbon footprint. A business will always be drawn to focussing on social issues material to them and in their place of operation.


There is now a far greater appreciation that financial return and adhering to ESG principles are not mutually exclusive. In fact - the opposite.

The Covid-19 pandemic has provided evidence that companies giving due attention to (a) corporate governance, (b) systemic risks and (c) sustainability are now best placed to provide their investors with attractive financial returns. Companies themselves are also understanding that, by giving consideration to all their stakeholders (and displaying such consideration through considered and clear narrative reporting), they will (i) reduce the potential for reputational and regulatory risk, (ii) be better placed to recruit talent, (iii) be more likely to secure capital investment and (iv) therefore have greater opportunities for growth and innovation – thus keeping them at the forefront of their respective markets.

Desptie this, we have a long way to go. “Greenwashing” remains prominent in this space. It is crucial that ESG principles are embedded into either a company’s considerations or a fund manager’s investment policy – and not merely paid lip service to. The end investor will also have to accept that ESG compliant investments may not perform as expected – clearly some are fully valued at the moment. However, as the industry progresses and managers understand better what is expected of them, such examples of “greenwashing’ are diminishing. The desire is for development of regulation (both at a domestic and international level) governing companies’ disclosure obligations which provides practical and comparable data that investors and other stakeholders can use to make their investment decisions and that encourages corporates to “walk the walk” as well as “talk the talk” when it comes to implementing ESG principles.

Appendix 1: Selection of key regulations, codes and organisations

  1. EU Non-Financial Reporting Directive (NFRD)

NFRD came into effect in 2018 and requires listed companies (and other public interest entities) to disclosue information on the way they operate and how they manage social and environmental challenges. An NFRD Guidelines Supplement was released in 2019 whereby the EU updated guidelines on non-financial reporting in annual reports of over 6,000 European companies, which integrated the recommendation of the TCFG (as detailed below).

  1. EU Sustainable Finance Programme

In 2018, the EU Commission released an “action plan for financing sustainable growth” – which sought to fully integrate sustainability into Europe’s financial regulatory system. Accordingly, the Commission released a package of measures to implement this plan, which included:

  • Taxonomy – creating a unified classification system on what can be considered environmentally sustainable economic activities (see below);
  • Disclosure and duties – specifically relating to sustainable investment and sustainability risk; and

Benchmarks – creating a new set of benchmarks to help investors better understand the relative carbon impact of their investments.

  1. Regulation on sustainability-related disclosures in the financial services sector (SFDR)

The SFDR, published in December 2019 as part of the EU’s package of measures relating to ESG, requires investment firms and asset owners to make disclosures in relation to ESG risks. Such disclosures are to be made: (i) in the documentation for a financial product; and (ii) on an asset manager’s website. The aim is to provide greater transparency on sustainability within the financial markets, thus avoiding greenwashing and ensuring comparability between financial products.

  1. Senior Managers and Certification Regime (SMCR)

The SMCR replaced the UK Approved Persons Regime (almost) in its entirety in December 2019 and puts a greater level of focus on senior management and individual responsibility within firms in the financial services sector. The SMCR consists of three main pillars: (i) the Senior Managers Regime; (ii) the Certification Regime (focussing on employees who are not senior managers but whose job can cause harm to the firm or its customers); and (iii) the Conduct Rules. The aim of SMCR is prevent / reduce harm to consumers and strengthen market integrity by increasing individual accountability within FS firms, particularly for senior managers. Note that as a result of Covid-19 the FCA introduced temporary alleviations to the SMCRs, including:

  • extending the maximum period firms can cover for a senior manager without being approved to 36 weeks (suspending the usual 12-week rule) (the Modification) – though it should be noted that firms will not be able to consent to the Modification after 30 April 2021 (and all current Modificaitons will cease on 30 April 2021); and
  • extending the deadline for firms to (a) assess the fitness and propriety of their Certified Persons; (b) train staff on the Conduct Rules; and (c) report Directory Persons Data – to 31 March 2021
  1. 172 Statements

Press on ESG is often dominated by the “E”. However, in addition to the FCA’s work, one much discussed development in relation to the “G” is the requirement that (in relation to financial years beginning from 1 January 2019) each UK incorporated company has to include an s.172 statement within their strategic report. The statement must describe how the directors have had regard to the matters set out in s.172 of the Companies Act 2006, which includes (amongst other matters):

  • the need to foster the company’s business relationships with suppliers, customers and others;
  • the impact of the company’s operations on the community and the environment; and
  • the desirability of the company maintaining a reputation for high standards of business conduct.
  1. Taxonomy Regulation:

Specifically aimed at fund/ portfolio managers creating a financial product[1], which has an objective of environmentally sustainable investments (Environmental Products). The Taxonomy Regulations, provide an EU-wide classification system that allows investors and businesses to identify how far an economic activity can be described as “environmentally sustainable”. It also requires managers of all non-Environmental Products to make a negative disclosure to that extent. The Taxonomy Regulation came into force on 12 July 2020.

  1. The Financial Stability Board Task Force on Climate-related Financial Disclosures (TCFD)

Established in 2017, the TFCD is a market-driven initiative that provides a set of recommendations to assist Companies in providing climate-related financial risk disclosures in their mainstream filings and reports. The aim is to provide a guide for organisations in G20 Jurisdictions (with public debt and equity) to use when providing information to investors, lenders, insurers, and other stakeholders – particularly in relation to ESG issues. For accounting periods beginning on or after 1 Janaury 2021, the annual financial reports of companies with a premium listing on the London Stock Exchange include a statement setting out whether it includes climate related financial disclosures consistent with the TCFD.

  1. UK Stewardship Code 2020 (“Stewardship Code”)

The Stewardship Code defines stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society. Accordingly, it is based around ESG issues and fundamentally aimed at those investing money on behalf of others in the UK. The Stewardship Code consists of 12 Principles for asset managers and asset owners, and 6 Principles for service providers - all supported by a set of public reporting expectations.

  1. United Nations Principles of Responsible Investment (UN PRI)

UN PRI are an international organisation with the principle aim of promoting the incorporation of ESG into investment decision-making. Launched in April 2006, UN PRI has over 3,000 participating financial institutions who became signatories to the UN PRI’s six key principles:

  1. Principle 1: Incorporating ESG issues into investment analysis and decision-making processes.
  2. Principle 2: Incorporating ESG issues into ownership policies and practices.
  3. Principle 3: Seeking appropriate disclosure on ESG issues by the entities in which we invest.
  4. Principle 4: Promoting acceptance and implementation of the Principles within the investment industry.
  5. Principle 5: Working together to enhance effectiveness in implementing the Principles.
  6. Principle 6: Reporting on activities and progress towards implementing the Principles.