The ESG Index (ESGI) represents the three key areas that encompass responsible investing (or “green investing”): environmental, social and governance.
The responsible investment market has been booming for several years, mainly in Europe and the United States. These investments are primarily based on ESGI. The main users of the index are investors who try to predict, as far as possible, the profitability of their investments over the long term. This is based on the assumption that a company’s commitment to ESG principles will significantly contribute to the company’s profitability in the short and long term.
ESGI analysis is not only for the purpose of investing in securities. It has also become a material consideration during acquisition operations and also has an impact on the image of a company (and on the image of its managers).
The three spheres of the ESGI essentially constitute combined criteria for evaluating the extra-financial performance of companies, that is to say the activities of companies in relation to subjects vital for the company but not necessarily profitable. The basic assumption when evaluating business enterprises according to ESGI is that large companies have corporate social responsibility and cannot operate with the sole purpose of maximizing profits.
This is a fundamental trend shift that continues to gain in relevance and momentum. In order to meet ESGI requirements, a company must complete each component as follows:
1. Environment: Environmental criteria are perhaps the most important and most discussed aspects. These criteria look at how a company and its business conduct affect the environment and the planet. For example, it examines whether the company complies with regulatory requirements (permits, waste recycling, etc.) or regularly implements technological initiatives (use of renewable energy).
2. Social: Social criteria primarily relate to the internal conduct of a company and examine the company’s policies towards employees, suppliers and customers. These criteria relate to gender equality, human rights, eradication of discrimination, affirmative action, compliance with equal pay laws, working conditions, etc. Additional criteria look at a company’s social contribution to the community through charitable organizations or local and community volunteering. These criteria are very important because they are relatively easy to measure (and change). As a result, we could see significant progress in a relatively short period of time.
3. Governance: These criteria examine a company’s management practices and the conduct of its management. They include anti-corruption measures, the diversity of management teams (representation of women and/or “disadvantaged” populations in key positions), executive compensation, etc.
It should be noted, as detailed below, that companies that more or less adequately meet the ESGI criteria must perform a long series of actions to benefit from the advantages inherent in meeting these criteria. Some of these actions are complex and require planning and implementation over several years.
The pursuit of companies that meet the ESGI criteria is the result of two key factors:
- progressive legislation.
- A new generation of investors.
Legislatures around the world were initially motivated to act in response to persistent warnings from scientists about humanity’s destruction of the planet and climate change, and in response to growing global awareness of the plight of weak populations (Work of the children, water shortages in many countries, etc.).
The European Union, for example, one of the leaders in passing legislation in this regard, has drafted several regulations focusing on ESGI. These regulations allow investment entities to screen companies for compliance with ESG criteria before investing in them.
Also in the United States, the Securities and Exchange Commission has advanced legal provisions that extend the reporting obligations of public companies regarding the environmental aspects of their operations. These include the obligation to declare the measures they take to reduce the company’s harmful impact on the environment. It is estimated that one in four dollars invested in the US capital market today goes to ESG investing, and those numbers are set to rise.
However, as mentioned above, it is not legislation that is driving this trend, but investors. This is a new generation of young, socially responsible investors who want to ensure that the money they invest does not have a negative impact on society and the environment. These new investors find it important to check whether their investments contribute to and are invested in companies that operate in a green and responsible way. They emphasize the quality of the environment, the rights of employees and the rights of women.
Corporate Social Responsibility
One of the important tools for advancing positive environmental and social action in business is the imposition of accountability on corporate executives since they govern the course of corporate operations and are ultimately responsible. the implementation of reasonable measures to prevent environmental violations and lead to responsible environmental conduct.
Israel’s corporate law contains several sections that impose obligations on directors to conduct a company’s business with integrity: duty of care, fiduciary duty, and determination that the actions of a corporate body amount to shares of this company. Israel has also enacted extensive environmental legislation that imposes specific and concrete responsibility on corporate executives for a company’s statutory compliance (such as laws on the prevention of various hazards and water laws).
These are basic regulatory obligations that primarily deal with violations and the imposition of criminal liability for them. But the legislation will no doubt also evolve in the near future to encourage companies to take action to improve their environmental and social performance.
Exploitation of ESGI by companies for the purpose of false advertising
Everyone agrees that ESG principles are important aspects of business operations. On the other hand, they also received a lot of reviews. This criticism is not aimed at the principles themselves. Rather, it is directed against companies that exploit these principles for public relations purposes. For example, the term “greenwashing” is a familiar term among investors. It refers to companies that spend more time and money on their image of being environmentally friendly and socially responsible than actually being. These companies disseminate misleading information that exaggerates their environmental and social activities. They do this when in fact their ESG activities are token efforts and they are still polluters, old-fashioned and not necessarily socially responsible.
Harnessing ESGI for this type of consumer and investor deception is not a new trend. Third sector organizations and even countries have been exposed for using growing social and environmental awareness as a public relations and marketing tactic.
What is the situation in Israel?
As noted, this trend is gaining momentum in both the United States and Europe. It enjoys the support of legislative and law enforcement authorities (both in securities matters and in relation to the regulatory requirements that each company must meet). In Israel, to date, the situation is slightly different.
Awareness is indeed growing. However, despite the fact that Israel has signed a variety of environmental agreements, corporate responsibility is still not sufficiently developed in Israel. At the same time, it is evident that Israel is also participating in the environmental awakening. The authorities are promoting measures to develop the environmental and social aspects of investments and within the business world. However, at this stage, when it comes to social investments and ESGI, these reports are still mostly voluntary. That is, companies in Israel are not subject to any reporting obligations.
ESG index in Israel
Nevertheless, Israel has indices allowing investors to examine the environmental impact of the companies in which they invest. This is the Environmental Impact Index of the Ministry of Environmental Protection or the “Maala” Index. It also enacts regulations and laws that impose obligations on companies and managers with regard to the environmental and social impacts of companies. In addition, in recent years, the Ministry of Environmental Protection has strengthened its enforcement measures. The ministry also monitors companies’ and businesses’ compliance with environmental legislation (air pollution, water pollution, licensing, etc.).
Undoubtedly, Israel is trying to catch up with European countries and the United States. Recently, the Knesset’s Ministerial Committee for Legislation approved a bill on climate change. The purpose of this bill is to create an organizational framework for the State of Israel to address the climate crisis while emphasizing key aspects of needed national efforts. These aspects relate above all to the minimization and prevention of greenhouse gas emissions according to structured objectives and plans. These measures aim to ensure that the State of Israel respects its commitments under the Paris agreements.
This legislation, together with global trends and the new generation of investors, will certainly contribute to the creation of a new style of investing in Israel. A style that will be part of the global trend and with the ESGI.