ESG is an exciting trend that is changing how we evaluate modern companies and their impact on the world. An increasing number of companies are listening and eager to respond. If you attend the upcoming OTC conference, for example, you’ll find that almost all the technical keynotes have to do with environmental sustainability. So, what is ESG and why should you care?
What ESG Is
The term ESG stands for “environmental, social, and governance.” When the term was first coined in 2005, the goal was to incorporate social ideals into business practices.
Per Investment Advisor Best Path Forward, ESG measures a company’s performance on three axes:
Environmental: Sustainability and resource efficiency, including
- Pollution and waste
- Climate change
- Energy efficiency
- Natural resources
Sample Issues: Greenhouse gas emissions, energy efficiency
Sample Metrics: CO2 emissions per unit produced, energy use per square meter
Social: More equitable societies and respect for human rights, including
- Gender and diversity policies
- Safety and quality controls
- Human rights and labor standards
Sample Issues: Health and safety, labor rights
Sample Metrics: Employee Accidents relative to total hours worked, number of active controversies
Governance: Accountable governance and transparent operations, including
- Corporate behavior
- Corporate governance
- Accounting practices
Sample Issues: Board independence, executive pay
Sample Metrics: Independent members relative to affiliated members, executive pay ratio, and disclosures
Why ESG Matters to Investors
If you follow the stock market, you may have heard the term ESG investing. ESG investors are different from traditional investors, who pick stocks based on short-term profits or personal values, such as an aversion to tobacco products. Instead, ESG investors recognize that, within every industry, some companies use more sustainable practices and therefore offer more value now and for the future. ESG is especially important to younger investors, who are passionate about a green future.
Today, Dow Jones, the S&P 500, and Nasdaq all offer ESG mutual funds, indices, and ETFs. There is even a standard for ESG ratings, maintained by the Sustainability Accounting Standards Board (SASB).
You can also get ESG recommendations from investment firms and publications. For example, Investor’s Business Daily offers the annual 100 Best ESG Companies: Top Stocks For Environmental, Social And Governance Values. Another online magazine, Environmental Science has an entire channel devoted to ESG.
Why ESG Is Important for EPC
The buildings we humans erect have a significant impact on the environment. According to construction insurer and consulting firm Marsh & McLennan, "The built environment generates 30 percent of all greenhouse emissions and 40 percent of energy use, while construction uses 32 percent of the world’s natural resources.”
As a result, here is why ESG is important for EPC:
- It reduces the environmental impact of construction. Construction’s impact on the environment is, perhaps, the most important reason that the EPC industry needs to adopt ESG standards. After all, the EPC industry is all about new beginnings: New office buildings, new factories, new refineries, new homes and apartment buildings. Few industries are in a better position to create the “green” buildings that will increase the sustainability of our world.
- It reduces costs. One of the biggest expenses is a construction policy that covers physical injuries, damage to surrounding properties, and other unanticipated events. From an insurance standpoint, the detailed planning associated with a high ESG rating translates into a low-risk profile. This high ESG rating/low-risk, best-in-class profile also makes it easier to borrow funds at favorable interest rates.
ESG planning can also lower construction costs. During the engineering and procurement phases, for example, the teams can work together to find components that are cost-effective but offer superior value. - It creates a ripple effect. A contractor’s decisions can have a ripple effect on other companies and the environment. Marsh & McLennan cites the example of the Mace Group. In 2020, the company reduced its carbon emissions by 50 percent, diverted two hundred tons of waste timber to alternative uses, and convinced most suppliers to switch from single-use plastics to paper-based alternatives.
- It attracts investors and clients. A high ESG rating tends to attract ESG investors who are looking for “green” investments. A high ESG rating also appeals to potential clients, who want to partner with best-in-class EPC companies.
How EPC Companies Benefit by Taking ESG into Account
You might assume that green practices are more expensive, would cut into a company’s profits, and lower its value. However, McKinsey shows that implementing ESG practices creates value in five ways:
- Appeals to ESG investors. The most apparent reason is ESG investing, the idea that investors want to support companies with high ESG ratings.
- Increases top-line growth opportunities. An ESG emphasis creates new growth opportunities for the lead company, as well as its subcontractors. As an example, McKinsey cites a large public-private infrastructure project in Long Beach, California. In turn, the lead company screened subcontractors on the basis of their ESG ratings.
- Reduces operating expenses. ESG practices can lower costs for resources and prevent pollution. Take the example of 3M, which saved $2.2 billion over the first twenty years of a sweeping revamp. Starting in the 1970s, the company prevented pollution upfront by reformulating products, improving its manufacturing processes, redesigning equipment, and recycling waste.
- Reduces regulatory and legal interventions. In most industries, government regulations only happen after something has gone wrong. An EPC company with a high ESG rating is associated with a methodical approach that will reduce the chance of incidents that alert the regulators.
- Attracts the best and the brightest workers. A strong ESG rating helps a company attract and retain high-quality employees. The positive reputation of a high ESG rating also increases an employee’s sense of purpose, job satisfaction, and overall productivity. This is especially important today, as “green” solutions require innovations in EPC.
- Optimizes investment and asset allocations. Because the company focuses on long-term sustainability, it can budget its capital for long-term goals, such as sustainable factories and equipment. Similarly, the company can avoid short-term investments that may cause long-term environmental damage.
Our Take on ESG
Here at Mintmesh, we expect ESG will be a significant factor for the next 30 to 40 years. It is our best hope to meet the environmental, social, and governance challenges that face our planet. However, you may have to adjust some of your current practices to succeed. We agree with Anthony Caletka, writing in PWC on two key points and add our own:
- Adjust new contracts to allow for uncertainty. Costs overruns are common on lump-sum turnkey (LSTK) projects, which disappoints shareholders. One solution is to adjust project bids to reduce your exposure to risk.
- Build a culture of transparency and collaboration. Another way to reduce risk is to develop a transparent, collaborative relationship with your client. This relationship will allow you to discuss critical ESG decisions, which can have ripple effects throughout the project.
- Inspire hope for the future. ESG challenges can be overwhelming, especially when you only look at the big picture. But when you zoom in, you can find yourself surrounded by innovations that build a more sustainable future.