• Environmental, social, and governance factors pose risks and opportunities both to individual companies and to investment portfolios as a whole.
  • Some environmental risks, like extreme weather events caused by climate change, can affect specific companies in key regions. Climate change is also a systemic risk that could negatively impact the entire financial system. 
  • Other risk factors in the social and governance categories – like extreme inequality or political instability – can be considered at the individual company and systemic level.

When we hear businesses talk about “ESG factors,” what they are really talking about is how they take into account a variety of risks and opportunities into their business practices. Here, we break down some examples of what environmental, social and governance risks and opportunities are really about.

What are Environmental risk factors and opportunities?

There are many types of environmental risk factors to consider. For instance, the increase in extreme weather events, including wildfires, storms and floods, have been causing billions of dollars of damage to the economy every year. According to the National Oceanic and Atmospheric Administration (NOAA), 2022 had one of the highest number of billion-dollar natural disasters, with a price tag of at least $165 billion in just the United States. As climate risks have proven to be financial risks, it is necessary for responsible companies and investors to take these environmental issues into account when making decisions.

Environmental opportunities can include cutting emissions and other types of environmental pollution, reducing exploitation of natural resources, and lessening the impact on surrounding communities. Cutting energy costs by increasing energy efficiency, switching to renewable energy, or insulating the buildings where companies operate are some of the key environmental opportunities that a greener economy is creating. These measures can also be used to tackle some long-term environmental risks that have financial consequences, such as fluctuating gas or oil prices. Companies might also look into how their products are sourced to avoid contributing to deforestation, which increases the risk of pollution, additional carbon emissions, and loss of biodiversity, all of which contribute to greater systemic financial risk because the effect of natural disasters can spread far and wide. 

Businesses taking steps to manage environmental risks and looking into new environmental opportunities can show they are taking a more responsible approach to how they operate and can protect their bottom line from ongoing risks and future crises. These businesses can also positively impact an investor’s broader portfolio by doing their part to avoid the growing impacts of a changing climate, which pose a significant risk to the financial system upon which investment returns depend.

What are Social risk factors and opportunities?

Social factors can include the working conditions of employees of a company and its suppliers, fair wages and benefits, whether or not the company management supports its workers being part of a union, and a commitment to racial and economic justice. Companies also routinely deal with social issues when it comes to ensuring the health and safety of their workers, or the fair treatment of all customers without discrimination.

Social factors can also include how companies impact the local communities in which they operate, or how they can support disadvantaged communities. Businesses might choose to implement fairer pay or better benefits to retain their workers and avoid the risk of high turnover in their staff; or they might choose to implement new projects that support underserved communities to increase their visibility and reputation. Managing social issues means that companies are better prepared to deal with a changing workforce, consumer base, and economy. 

How companies manage these issues can also affect an investor’s broader portfolio, typically composed of many different investments reflecting a wide cross-section of the economy. For example, if workers are not paid enough to cover their basic needs and purchase consumer products, this can negatively affect economic growth and decrease portfolio-wide investment returns.

What are Governance risk factors and opportunities?

Governance factors include how the corporation makes decisions, compensates executives, listens to shareholders and stakeholders, and manages its engagement in politics and lobbying. Good corporate governance means managing a company in a way that is legal, ethical, transparent and has integrity. This can involve steps such as having clear internal rules to avoid conflicts of interest, maintaining accountability processes to avoid corruption or bribery, ensuring diversity in the board of directors, or transparency on political donations and lobbying. For example, many customers are paying close attention to whether a company’s lobbying lines up with its corporate values and public statements. If there is a disconnect, companies can face bad press, boycotts, or targeted social media campaigns, all of which may result in a decrease in company value in the short, medium, or long term.

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