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Understanding ESG’s Environmental Pillar

The E in ESG takes into account an organisation’s environmental impact and sustainability, focusing on areas such as carbon footprint, resource management and policy.

by Niall McCarthy 4 min

    The environmental pillar of ESG focuses on how an organisation performs with regards to the physical environment, taking areas into account such as energy use, pollution, natural resource utilization, conservation record, the treatment of animals and so on. Given the magnitude of the multitude of crises facing the planet and the increasing severity of environmental risks for companies, the E element of ESG has become more and more relevant.

    With governments all over the world pledging new and more stringent green standards, companies are looking more closely than ever at their environmental impact. Transparency on this issue is not just key for investors put also public image. In addition, a transparent environmental policy also helps drive company morale and creates trust.


    Why the E matters

    All of the ESG pillars matter but the E is fundamental. Companies that take the initiative towards building a culture of sustainability have a higher chance of boosting customer engagement and accessing capital. On the other hand, environmental setbacks can prove devastating. Here are five key reasons why the E matters.

    1. Financial risks: Organisations that fail to implement environmental policies and safeguards can suffer massive financial repercussions. Take the worst environmental disaster in US history as a key example. BP was fined $4.5 billion for the 2010 Deepwater Horizon oil spill, the largest criminal fine recorded in the US at that time. Previously, the largest penalty for a purely environmental offence was the $125 million imposed on Exxon for the 1990 Valdez oil spill. While a lack of enthusiasm to cut carbon emissions can raise eyebrows among investors, failure to develop environmental safeguards can prove financially catastrophic.
    2. Battered reputations: Unsurprisingly, events such as those mentioned above can destroy corporate reputations that took years to forge. Incidents like oil spills, plastic waste dumping or the poor treatment of animals can lead to public revulsion and reduced brand engagement. Volkswagen’s 2015 emissions scandal serves as a notable example. The damage to the German carmaker’s previously solid reputation and the breach of trust with its customer base proved every bit as serious as the financial penalties imposed upon it.
    3. Violations in the era of social media: To a certain extent, everybody with a smartphone can be considered a potential journalist today. As a result, it is getting more difficult for companies to cover-up cases of environmental wrongdoing. Last year, images of raw sewage being pumped into the UK’s waterways went viral on social media, attracting wall-to-wall media coverage. The citizen whistleblowers campaigned until the issue was debated in parliament where it was agreed that water companies cut their discharges of raw sewage.
    4. Corporate values and employee engagement: Environmental setbacks can keep a company on the front pages of newspapers for days and prove demoralizing for employees. On the other hand, building a company culture of sustainability sends the message to staff that they are part of something that matters. Active involvement in environmental issues within the company can also reap dividends as well as proving beneficial for the organisation as a whole. Initiatives such as a “bike to work” scheme or remote working to cut down on emissions can also boost employee engagement even further.
    5. Being sustainable pays off: Even though initiatives such as a “bike to work” scheme or the installation of solar panels on an office building can prove expensive initially, they can pay off in the long run. In addition to boosting energy efficiency, they can lead to a jump in customer demand and investor interest. Notorious polluters also have a harder time accessing the best talent with prospective applicants more likely to opt for more sustainable employers.

    Calculating the environmental score

    In order to better understand what companies need to keep in mind, it can be helpful to look at how an environmental performance is evaluated. For example, S&P Global assesses companies’ environmental footprints through four factors:

    • Greenhouse gas emissions
    • Water use
    • Waste & pollution
    • Land use & biodiversity

     

    According to S&P Global, these criteria “weigh potential social and governance risks to determine an entity’s capacity to operate successfully, along with a preparedness assessment of its capacity to anticipate and adapt to a variety of long-term environmental disruptions, ultimately determining our ESG score”.

    While environmental factors used to be championed for their public relations value, their impact has become far more visible in recent years, particularly in the eyes of investors. A positive ESG score pays off, leading to a direct financial impact as well as putting an organisation in a more competitive position.

    The greenwashing problem

    More and more organisations are adopting sustainable business practices but, unfortunately, not all of those initiatives are being conducted in good faith. In some cases, companies are jumping on the green bandwagon simply to enhance their public image rather than pursuing a legitimate interest in tackling their environmental footprint. “Certified green”, “eco”, “climate neutral” and “natural” are just some of the corporate buzzwords associated with a company taking a more sustainable approach and sometimes that’s just what they are: buzzwords without substance.

    Greenwashing is a form of marketing spin that deceptively persuades the public that an organisation’s products, aims and policies are environmentally friendly and the illusion is often used to distract from unsustainable business practices. The term was first coined by New York environmentalist Jay Westerveld in 1986 when he critiqued the hotel industry’s double standards regarding the reuse of towels.

    While the term has continued to be used in an environmental context, some academics also use it in an economic or social context. Evidence of the practice can emerge in the form of spending differences such as an organisation putting more time and funding into “green” advertising than sound environmental practices.

    As more and more people opt to buy sustainable products, corporate greenwashing can mislead customers into acting unsustainably, resulting in a serious breach of trust when the company in question is called out. Once again, the Volkswagen emissions scandal provides another good example of how this can happen. Other instances worth keeping in mind include Nestlé’s 2018 statement detailing its ambitions for its packaging to be 100% recyclable or reusable by 2025. It was pointed out that the company did not release any timeline or targets to accompany the plan with Greenpeace labelling it “more of the same greenwashing baby steps to tackle a crisis Nestlé helped create”.

    So, given the serious environmental, societal and financial repercussions of greenwashing scandals, how can companies in search of a better ESG framework prevent it? Going down the legal route and pursuing recognised standards from valid organisations is one strategy. For example, meeting the EU’s organic labelling standards would be a sound approach for a food manufacturer seeking to become more sustainable.

    Other strategies include building a culture and reputation of transparency as well as a policy of verification. Backing up and validating environmental initiatives through measures such as certification (as would be the case with an organic label) can help a company show that its efforts are really genuine.

    The aspects of the E under scrutiny

    Investors and regulators alike are now asking tough questions about how companies are reducing their carbon footprints and real progress has to be demonstrated in a number of areas. Here are some of the areas that are attracting the most scrutiny.

    Energy use

    When it comes to reducing a carbon footprint, focusing on energy use is a good place to start. In ESG, rating agencies are closely focusing on how quickly companies are decarbonizing their energy mix and this is fuelling considerable growth in renewables, particularly solar and wind energy. Electric vehicles are also in hot demand with countless logistics companies exchanging their dirty diesel-guzzling fleets for quiet, clean and emission-free options – a clear statement of sustainable intent. The process of making energy use greener can be broken down into four main steps:

    In order to better understand what companies need to keep in mind, it can be helpful to look at how an environmental performance is evaluated. For example, S&P Global assesses companies’ environmental footprints through four factors:

    • Renewal: Conducting a transition towards more sources of renewable energy
    • Recovery: Addressing improvements in energy efficiency
    • Removal: Reducing greenhouse gas emissions
    • Reporting: Measuring and tracking sustainability performance

     

    While the financial investment necessary to decarbonize a company’s energy mix can seem daunting at first, especially for a project such as a new electric vehicle fleet, organisations are usually able to avail of incentives and tax credits to kickstart the process while installation costs for renewables have fallen considerably in recent years. Some of America’s biggest companies have already taken the step to switch to solar and are now leading by example.

    According to the most recent “Solar Means Business Report” from the Solar Energy Industries Association, US businesses and the top global brands have been making historical investments in solar energy. In 2019, the year the report was released, Apple had the most installed solar capacity of any country in the US with 398.3 megawatts. It was followed by Amazon (369 mw), Walmart (331 mw), Target (284.8 mw) and Google (245.3 mw).

    Pollution

    Every company generates some form of waste from discarded cardboard and paper right up to toxic materials that are expensive and complex to dispose of. In some cases, improper precautions or negligence can lead to pollution, broadly defined as when any substance that harms or could harm people or the environment gets into the air, water or ground. Air pollution is particularly problematic and the WHO estimates that it kills some seven million people each year.

    Pollution is a key factor for ESG investors due to its impact on health and potential reputational carnage. In June 2021, a survey of Investopedia and Treehugger readers found that pollution/waste management is actually the top issue for ESG investors, ahead of fair and safe working conditions and carbon emission reduction.

    For companies seeking to mitigate environmental damage and any ensuing financial or reputational consequences, it makes sense to take steps towards pollution prevention (P2). This strategy refers to eliminating pollution at the source, rather than cleaning it up after it occurs. While simple strategies include water and energy conservation, more elaborate prevention frameworks take into account improvements in the manufacturing process. When it comes to implementing an effective P2 strategy, it is worth keeping the following steps in mind:

    Update processes and focus on equipment: In terms of processes, a basic step involves phasing out old lighting and replacing it with more energy efficient technology. Likewise, water-usage should be analysed and improved to boost conservation. Machinery should also be appropriate in terms of size and energy usage, considering the tasks at hand.

    Substitute materials: Harmful or damaging substances can be replaced by more environmentally friendly alternatives. Examples include the use of recycled plastic instead of new plastic in products as well phasing out synthetic fibres and bringing in natural fibres instead. Eliminating packaging or using better materials to give your product a longer life-cycle also helps reduce its environmental impact.

    Recovery and repair: Re-using products and materials where possible is also an aspect of a good P2 framework and it can cut down on the amount of new material an organisation has to purchase. Melting down and re-using scrap metal or recovering metal through in exchange are examples of how this can be achieved. Likewise, machines, vehicles or computers should be repaired where possible, rather than discarded.

    Training programs and maintenance: P2 training will help employees use equipment in the most energy-efficient way possible. Regular maintenance also helps prevent faults and potential accidents involving waste.

    Implement measures to prevent spills or leaks: Install splash guards and drip trays around equipment, leak detection equipment, overflow alarms and automatic shut-off valves. Pipes and storage containers should be inspected regularly.

    Eliminating bad purchasing: Poor purchasing decisions and bad inventory management wastes money and can prove detrimental to the environment. Ways to remedy this include the creation of a list of approved partner manufacturers with certified energy standards or purchasing items made with recycled material.

    Conservation record and notable initiatives

    It goes without saying but a bad ESG score or a poor conservation record will of course act as a deterrence to socially-conscientious investors and customers alike. Businesses actively pursuing sustainable practices and leveraging corporate strength for positive environmental change, on the other hand, will prove a much better proposition.

    Even though a 2017 report found that just 100 large companies are responsible for 71% of industrial greenhouse emissions since 1988, every organisation has a part to play in the fight against climate change through the implementation of cleaner and more sustainable business practices.

    Some of the big players are already taking note, particularly in the tech sector. Amazon launched a $2 billion Climate Pledge Fund aiming to support the development of sustainable and decarbonizing technologies and services in order to facilitate the transition to a low-carbon economy. Elsewhere, Apple has committed to being 100% carbon neutral across its entire business by 2030 while Dell has pledged for a 50% reduction in emissions by the end of the decade.

    Swedish furniture maker Ikea has also implemented sustainability initiatives such as purchasing forest land, buying back furniture from customers and selling spare parts for its products. It also plans to rely exclusively on recycled and renewable materials by 2030.

    One company that has really gone the extra mile in terms of sustainability is US clothing brand Patagonia. Founded by world-renowned environmentalist Yvon Chouinard, Patagonia has been recognised as a Champion of the Earth by the United Nations Environment Programme. It mission statement reads that “we’re in business to save our home planet” and it has earned plaudits for its sustainable supply chains and advocacy for the environment. Nearly 70% of Patagonia’s products are made from recycled materials and the company plans to grow that figure to 100% by 2025.

    Since 1986, Patagonia has also contributed at least 1% of its annual sales to the preservation and restoration of the natural environment. Thanks to that pledge, it has provided more than $100 million to grassroots organisations and helped train thousands of young activists over the past three decades. The “1% for the Planet” initative now encourages other companies to follow suit. When it comes to leading the way on corporate conservation, there are few better examples than Patagonia.

    Treatment of animals

    As investors turn more and more towards ESG topics, animal welfare has emerged as a key consideration. It is also a public issue with real political and reputational consequences. The World Organisation for Animal Health (OIE) defines animal welfare as how an animal copes with the conditions in which it lives whereby it is in a good state of welfare if it is healthy, comfortable, well nourished, safe, able to express innate behaviour and if it is not suffering from pain, fear and distress.

    While animal welfare is most important for animals, it can have repercussions for business performance. Poorly treated animals can impact their ability to grow, produce and reproduce. Knock on effects are then seen in both productivity and food quality where there is a noticeable impact on financial performance. Legislation has also been getting tougher around animal welfare and this has had consequences for farmers and companies.

    The European Union has had a wide range of legislative provisions concerning animal welfare in place since 1974 and animals are recognised as sentient beings under EU treaties. Current laws are among the most stringent in the world with cages banned for laying hens and group housing required for pregnant sows. Elsewhere, the Indian Prevention of Cruelty to Animals Act forbids the caged confinement of animals and highlights just how far global protection laws have come.

    Failure to comply with local laws, regulations and standards can see companies working with animals lose their license to operate or receive fines. Violations that are publicized can also lead to reputational damage and the loss of customers.

    The CDC Group reported that in the United Kingdom, the UK Farm Animal Welfare Council has established the Five Freedoms that underpin international dialogue on animal welfare. Even though they do not refer to established standards, they can act as solid guidelines for organisations seeking to introduce high states of welfare:

    • Freedom from hunger and thirst: Access to fresh water and a diet to maintain full health and vigour.
    • Freedom from discomfort: Provision of an appropriate environment including shelter and a comfortable resting area.
    • Freedom from pain, injury or disease: Prevention through rapid diagnosis and appropriate treatment.
    • Freedom to express normal behaviour: By providing sufficient space, proper facilities and the company of other animals of its kind.
    • Freedom from fear and distress: Avoiding mental suffering by ensuring proper conditions and treatment.

     

    What does this all mean for investors? Before making a decision, they should determine whether companies in agriculture, aquaculture, food, beverage or other sectors involving animals have appropriate welfare policies and procedures in place as well as whether they are abiding by local laws.

    Conclusion

    Corporate sustainability practices are evolving rapidly and a slew of new environmental legislation is on the horizon. With sustainability reporting frameworks and standards set to become ever tighter and more complex, companies are advised to put more effort into ESG as soon as possible, particularly its environmental pillar.

    Along with limiting the possibility of environmental setbacks and financial repercussions, early action will ensure organisations are well positioned to meet emerging reporting requirements in the future. Proactivity will also build a better sustainability culture, lead to improved worker engagement and significantly enhance the prospects of attracting the attention of green-minded investors.

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    Niall McCarthy
    Niall McCarthy

    Niall is a Content Writer at the EQS Group. Originally from Ireland, he previously worked as a journalist, which included reporting on major corruption trends worldwide.

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