You may have heard the acronym ESG in the news recently. The three letters have gained international attention in the last year as a pandemic, natural disasters, and social unrest have provided unsettling reminders of the enormous influence institutions have on society. ESG stands for Environmental, Social and Governance, and refers to the three central factors affecting the sustainability of an institution’s operating model and its impact on the well-being of society. These institutions, corporate, educational, or other, can be evaluated based on their commitment to the responsible use of resources, financial, environmental, and human.
It has long been acknowledged that organizational leaders risk reputational damage if ESG events are not handled appropriately — think oil spills, deforestation, or biased hiring practices. More recently, however, it has become increasingly clear that ESG factors also affect credit and investment performance as failure to achieve higher ESG standards may mean an institution and/or its operating model is directly contributing to additional societal risks, including climate change, continuation of racism and sexism, conflicts of interest and even corruption. These and other ESG factors are not sustainable and, when identified, can lead to credit rating downgrades and/or other negative financial consequences to an investment.
The acknowledgement that success or failure associated with each of the three ESG dimensions have a direct relationship to financial performance has led to the inclusion of ESG in credit risk analysis as an international best practice. More and more investors now consider ESG factors in their evaluation of opportunities to deploy capital. This includes the broader financial market, like publicly traded stocks and bonds, as well as more local investments like those in P3 opportunities at higher education institutions.
Though ESG assessments remain mostly qualitative and evidence-based, a push for the mandatory disclosure of ESG performance is gaining momentum. Standard & Poor’s (“S&P”) has implemented a framework for assessing credit risk from ESG factors in order to generate scores that broadly align with its credit ratings for corporations, higher education institutions, and other organizations. S&P’s Scorecards, as they have come to be known, allow ESG factors to be considered in the credit risk analysis in a structured way, while simultaneously working through regular credit assessment process. The Scorecard enables ESG factors in several areas to be considered, including management and governance, country and industry risk, competitive position, and cash flow/leverage.
It is encouraging to see the call for greater awareness and attention to the environmental, social, and governance impact that each institution has on the communities they operate within and serve. We believe these efforts align well with our core principle of sustainability – environmental, human, and economic. We should all strive to be leaders in our respective industries by being innovative and bold, while remaining humble to learn and evolve as new, better information and processes are learned as this is the best way to ensure the long-term success for all.