Environmental, Social, and Governance (ESG)

What is ESG?

ESG stands for environmental, social, and governance. It’s a framework that investors and other stakeholders use to measure an organisation’s impact on the environment and society and assess its governance practices. In simple terms, it is a structured measure of sustainability that allows for assessing an organisation’s overall impact and resilience.

What are the three ESG pillars?

1. Environmental factors: The environmental pillar assesses how an organisation impacts and interacts with the natural environment. It focuses on managing resources responsibly, minimising environmental harm, and addressing global challenges like climate change. Organisations excelling in the environmental pillar actively reduce their ecological footprint and prepare for regulatory and market shifts toward sustainability. Key areas include:

• Climate change: Strategies to reduce greenhouse gas emissions (carbon neutrality goals, energy efficiency).
• Energy consumption: Use of renewable energy sources and reduction of energy waste.
• Resource conservation: Sustainable sourcing, water usage, and waste reduction.
• Pollution and waste: Managing chemical waste, air quality, and mitigating pollution risks.
• Biodiversity and land use: Protection of ecosystems and preventing deforestation or habitat destruction.

2. Social factors: The social pillar evaluates how a company manages relationships with employees, suppliers, customers, and the broader community. It reflects the organisation’s commitment to fairness, equality, and societal well-being. A strong social performance improves brand reputation, employee engagement, and community trust.

Key areas include:

• Employee welfare: Providing safe working conditions, fair wages, and promoting equality, diversity and inclusion (ED&I).
• Labour practices: Elimination of child labour and forced labour, and ensuring workers’ rights throughout the supply chain.
• Customer relations: Ensuring product safety, data privacy, and enhancing customer satisfaction.
• Community engagement: Investing in local communities, supporting education, and charitable causes that have a positive local impact.
• Human rights: Upholding ethical standards across operations and supply chains.

3. Governance factors: The governance pillar examines an organisation’s leadership, transparency, and accountability practices. It ensures that decision-making aligns with ethical principles, complies with regulations, and balances stakeholder interests. Governance underpins the other two pillars, as strong leadership commitment is essential for implementing environmental and social initiatives effectively. Key areas include:

• Board composition: Diversity, independence, and expertise of board members.
• Executive compensation: Fair and performance-linked pay for executives, avoiding excesses. Executive pay is increasingly linked to organisational ESG performance, highlighting its growing importance.
• Responsible business practices: Policies to combat corruption, bribery, and insider trading.
• Transparency: Clear financial reporting and disclosure of ESG performance.
• Stakeholder rights: Protecting shareholders and ensuring fair treatment of all stakeholders.

Why is ESG important?

ESG as a term was first introduced by the UN in their 2004 Who Cares Wins Report. The report demonstrated how to embed the ESG factors into an organisation’s operations, breaking down the concept into its three basic components: environmental, social and governance. In 2006, ESG formed a basis of Principles for Responsible Investment (PRI), which recommended incorporating the non-financial performance and impacts of organisations into its financial evaluations. The financial crisis of 2008 highlighted the importance of good governance.

Since then, the ESG concept developed further and is now mainstream. It’s used widely by various stakeholders, including consumers, who increasingly favour brands that demonstrate strong sustainability and ethical practices. Beyond being a tool for investors, ESG is widely adopted by companies to align with global sustainability goals, such as the UN’s Sustainable Development Goals (SDGs) and the Paris Agreement. Governments and regulatory bodies have also integrated ESG considerations into various mandatory reporting frameworks.

ESG is crucial for building resilient, ethical, and sustainable organisations. By tackling environmental challenges like climate change, promoting social equality, and ensuring transparent governance practices, ESG creates long-term value for stakeholders. Organisations that prioritise ESG can better mitigate risks, improve their reputation, and attract responsible investors and customers.

ESG goes beyond financial benefits, aligning business practices with global sustainability goals, building trust and commitment among employees, customers, and communities. In a world increasingly driven by environmental and social expectations, ESG has become essential for achieving sustainable growth and maintaining a competitive advantage.

Why is ESG critical in procurement and supply?

In procurement and supply chain management, ESG plays a critical role in ensuring sustainability and ethical practices throughout all operations. Stakeholders are increasingly requiring organisations to ensure their suppliers and partners meet ESG standards, such as reducing carbon emissions, upholding fair labour practices, and using ethically sourced materials. Procurement and supply teams are uniquely positioned to drive ESG adoption by embedding these principles into supply chain management activities, such as supplier selection, contract negotiation, and performance monitoring, leading to improved sustainability practices globally.

By prioritising suppliers with similar ESG values, organisations can mitigate the risk of supply chain disruptions, regulatory non-compliance, or reputational damage. ESG procurement practices build more resilient supply chains, ensuring readiness for future environmental and social challenges and reducing the risk of supply shortages.

Embedding ESG principles in procurement activities also drives innovation by encouraging suppliers to adopt greener technologies and responsible practices. Transparency and traceability are also becoming more achievable, as organisations leverage technology like blockchain and AI to monitor ESG compliance throughout the supply chain.

What is an ESG Metrics Framework?

An ESG metrics framework is a structured approach for measuring and evaluating organisation’s performance in environmental, social and governance areas. It assists organisations in providing clear indicators and metrics to assess how well they’re managing risks and opportunities related to sustainability and responsible operating practices.

CIPS developed a useful ESG Metrics Framework that organisations can use to drive improvements in their supply chains. This framework highlights the importance of aligning procurement and supply chain ESG metrics with organisational strategy and board-level goals. Procurement and supply play a critical role in achieving broader ESG objectives. Procurement and supply chain activities are often where the most significant ESG risks and opportunities arise, e.g. carbon emissions reduction, promoting fair labour practices, and increasing supplier diversity. Aligning these operational metrics with organisational and board-level goals ensures that sustainability is not treated as an isolated function but as an integral part of the organisation’s overall strategy. An example of a KPI based on the CIPS ESG Framework is:

• Board-level goal: Achieve net-zero carbon emissions by 2030 and demonstrate leadership in environmental sustainability.
• Organisational level: Embed sustainability into all business operations, including supply chain management, by prioritising partnerships with suppliers that adhere to recognised sustainability standards (e.g., ISO 14001).
• Procurement function measure: the percentage of total supplier spend allocated to suppliers certified with ISO 14001. For example:
  • KPI: achieve 80% of supplier spend with ISO 14001 certified suppliers by 2027.