An A-Z of ESG: Part one

By Mollie Thornton, senior investment manager, Parmenion

The world of sustainable investing is relatively immature and there is much to still to learn, but a myriad of acronyms, new definitions and what some would call ‘jargon’ are not helping investors navigate the intricacies of ESG.

In this three-part guide, Parmenion’s senior investment manager Mollie Thornton provides a glossary of terms and what they mean. First, Thornton takes a look at A to I.

A is for animal testing

Animal testing is an important issue for many ethical investors. Fund policies on animal testing vary.  Some funds look to minimise all exposure to animal testing for whatever purpose. Others allow exposure to animal testing for medical purposes and where required by law – for example in the testing of new foods or household products – as long as it is in line with the highest standards. This includes complying with the three ‘Rs’: replace, reduce and refine the use of animals in testing wherever possible.

B is for (green) bonds

Bonds are investments offered by governments and companies. They borrow money from investors and, in return, promise to pay back the investment plus an agreed rate of interest over a defined period of time.

In the case of green bonds, the money borrowed is used for environmental and climate-related projects.

In November 2020, as part of his 10 Point Plan for a Green Industrial Revolution, Rishi Sunak announced the launch of a green gilt in 2021, with the proceeds to be solely ring-fenced to tackle climate change, and transition to a more sustainable future.

C is for climate crisis (and carbon footprint)

Climate crisis (also known as climate emergency, climate change or global warming)

The climate crisis is a term used to describe the human-induced emission of greenhouse gases, the subsequent warming effects, and the immense societal challenges which arise as a result of increased extreme weather and climate feedback loops.

Greenhouse gas emissions are primarily caused by the burning of fossil fuels, but other major contributors include agriculture and deforestation.

Carbon footprint

This is the total amount of greenhouse gases – including carbon dioxide – released into the atmosphere by a person, product, company, or country. It is an important measure due to the direct link between greenhouse gas emissions and climate change. According to the Intergovernmental Panel on Climate Change, rapid and significant reductions in greenhouse gas emissions are needed globally to limit global warming to 1.5-2 degrees above pre-industrial levels to limit the worst effects of climate change.

D is for diversity & inclusion

Diversity and inclusion within a business are intrinsically linked.

Diversity is about recognising the benefits of a diverse range of thoughts and perspectives to reflect the society in which a business operates.

Inclusion is about providing everyone in the business with equal access to opportunities and resources by removing all barriers, discrimination and intolerance.

According to the 2020 study Diversity Wins: How Inclusion Matters by McKinsey & Company: “For diverse companies, the likelihood of outperforming industry peers on profitability has increased over time, while the penalties are getting steeper for those lacking diversity.”

When it comes to ESG, ethical and sustainable investing – diversity and inclusion fall under the “social” element of ESG due diligence.

E is for environmental (and ethical)

Environmental

The “E” in ESG. This element focuses on the impact business operations have on the environment. The focus is not just on the direct operations of the business, but their entire supply chain.

Ethical

Ethical investing is an umbrella term used to describe the practice of choosing your investments based on your moral or ethical beliefs. It has been around for a long time, first recorded in the 18th Century when the Quakers restricted members from spending time or money on the slave trade.

F is for fossil fuels

Coal, oil and natural gas are all fossil fuels. They are formed by natural processes over millions of years and contain high percentages of carbon. When burned they release energy and, as of 2018, account for 85% of the primary energy consumption in the world.

As well as releasing energy, they release large amounts of carbon dioxide. Carbon dioxide or CO₂ is a greenhouse gas and one of leading contributors to global warming and ocean acidification.

G is for governance (and greenwashing)

Governance

The “G” in ESG. Governance refers to business management practices. In governance, transparency and disclosure are crucial and it is important that companies have policies for all aspects of their business conduct, like ongoing monitoring of the effectiveness and remuneration of senior management.

Greenwashing

Greenwashing is a technique used by some businesses to mislead the general public and investors about their ESG credentials. This could be through false or exaggerated claims.

For example, some fund managers may suggest that analysis of ESG issues is fully embedded into their investment process. However, it is important for them to evidence how their ESG analysis feeds into their decision-making, and whether it has a meaningful effect on how they select companies and construct portfolios.

H is for human rights

Human rights are the most basic rights and freedoms that every person, no matter their age or location in the world, are entitled to. They are based on dignity, liberty and equality.

In the UK, human rights are protected by the Human Rights Act 1998 which was based on the Universal Declaration of Human Rights. This historic document developed by the UN in 1948 outlines the basic freedoms everyone is entitled to.

When it comes to ESG, ethical and sustainable investing – human rights fall under the “social” element of ESG due diligence.

I is for impact investing

Impact investing is designed to create targeted, measurable outcomes that benefit society or the environment, in addition to positive financial returns.

For example, this could be the building of affordable housing, or increasing access to energy, healthcare or education in communities that need it.