A number of investors are choosing to invest in securities with an environmental, social, and governance (ESG) focus that may align with their values and investment goals. Many see ESG companies as being potentially more sustainable long-term. But determining whether a company’s ESG strategies are having the desired impact requires the use of ESG metrics to measure progress and enable accountability.
In addition, these days many investors also want to know how well companies are managing the risks associated with climate-related changes — which also requires metrics that can show whether a company is meeting key standards.
These concerns aren’t new, but they have driven a number of new ESG-focused regulatory efforts here and abroad. As yet, however, there isn’t a universal set of ESG metrics used by all investors or financial firms to evaluate a company’s progress toward ESG goals, or better manage ESG risks. What’s more, the regulatory landscape in this sector is evolving, which, for the near future, may make it challenging to track certain metrics over time. That said, there are a number of frameworks that companies and governments have embraced that can inform investors’ choices.
Key Points
• With the growing appeal of ESG strategies, there is also a need for reliable ways to assess companies’ ESG performance and risk mitigation.
• ESG metrics are necessary for accurate company disclosures, which also support transparency and accountability.
• The use of ESG metrics and disclosures can also help investors compare companies within and across industries.
• A number of organizations are establishing mandatory standards and/or compliance rules, although some are in flux or facing legal opposition.
• At the moment, companies can choose from a range of ESG frameworks and standards.
What Is ESG Investing?
ESG stands for environmental, social, and governance standards that can help people assess whether companies are meeting certain criteria, as well as whether they are mitigating ESG-related risk factors that may impact performance.
• Environmental factors capture how well a company safeguards the physical environment (e.g., reducing emissions, pollutants).
• Social criteria refer to employee safety, fair labor practices, community investment, relationships with customers and vendors.
• Governance factors include issues of leadership, fraud prevention, transparency in accounting and reporting, and more.
ESG investing began in the 1970s, broadly speaking, although impact investing in various forms has been around for centuries.
At first, investing with the aim of creating positive change for society and the planet seemed anchored in a kind of “do-goodism” and less focused on financial outcomes. In the last 20 or 30 years, though, investors have become interested in socially responsible investing (SRI), as many funds in this category have shown themselves to offer returns that are comparable to traditional strategies, according to a report published in 2023 by Morningstar, a fund rating and research firm.
ESG Metrics Are Key to ESG Reporting
Thus, with the growing appeal of ESG investments to some investors, there is a commensurate need for reliable ways to assess companies’ ESG performance when choosing to invest online or through a traditional brokerage.
ESG frameworks help companies, as well as investors, assess an organization’s stated aims in terms of meeting ESG standards. In theory, relying on a common set of metrics should help encourage more efficient and transparent ESG reporting.
• ESG metrics establish a layer of transparency and accountability.
• Reliable ESG reporting helps build trust and a positive image with investors, communities, and other stakeholders.
• In addition, companies that adhere to ESG standards may be able to demonstrate better risk management.
Recommended: Beginner’s Guide to Sustainable Investing
What Are ESG Metrics?
Until now, ESG metrics and reporting standards have been largely proprietary or voluntary. But owing to widespread concerns about climate change and climate-related risk factors, thousands of companies around the world have adopted voluntary frameworks and metrics in recent years.
There are thousands of metrics in use, many are specific to certain industries. Common ESG metrics typically assess how well an organization is limiting pollutants and emissions, meeting renewable energy targets, upholding fair labor standards, adhering to transparency in accounting, corporate board selection, and more.
The Use of ESG Frameworks
Companies may be required to use certain metrics in their reporting and disclosures. Here too there is considerable variation.
For example, the Global Reporting Initiative (GRI), which has a voluntary governance structure, is a nonprofit organization that was established in 1999 to create a set of guidelines that help companies and governments disclose their efforts in light of climate change, human rights, and corruption.
More than three-quarters (78%) of the world’s largest corporations have adopted the GRI standards, making it the most common ESG framework at the moment.
In addition, there has been a rise in the number of organizations that are establishing mandatory standards and/or compliance rules that require standardized reporting and verifiable metrics regarding ESG performance.
For example, the Corporate Sustainability Reporting Directive (CSRD) began rolling out mandatory ESG reporting rules in January of 2024 in the European Union. The CSRD compliance rules impact non-E.U. companies, as well, about a third of which are based in the United States.
Similarly, some financial institutions have created screener tools that investors can use to evaluate certain securities, but these are typically proprietary and cannot be used to evaluate investments at a different institution.
SEC Climate-Disclosure Rules on Hold
Another widely watched set of reporting requirements was led by the Securities and Exchange Commission (SEC) over the last few years. The SEC adopted new rules in March of 2024, which established a higher bar for companies and required them to disclose ESG-related operational risks and expenses, as well as efforts to meet sustainability targets: e.g., emissions reduction.
But those rules were quickly challenged and remain on hold at the time of publication. Likewise, similar efforts in states like California and elsewhere have been stalled.
Recommended: The Growth of Socially Responsible Investing
The Importance of ESG Metrics
Although the landscape of ESG frameworks and reporting standards is still evolving, and is largely in flux, ESG metrics are important because they help investors to gauge a firm’s impact on environmental issues, societal issues, and issues of corporate responsibility against a set of comparable peers.
Since many investors who are interested in ESG strategies are also committed to making an impact with their money, being able to benchmark outcomes is important.
The Limitations of ESG Metrics
However, it can be difficult to measure ESG policies across different industries, as no official regulations for standardized ESG reporting currently exist. For example, a financial institution might require different standards for energy efficiency vs. an agricultural company or an actual energy producer.
Finally, some of the existing standards are qualitative and may be prone to subjectivity, which can make the ESG evaluation process difficult to quantify. These can all present challenges when you’re trying to apply ESG principles to your investing strategy.
Having an awareness of some of the limitations around these metrics can help investors use the currently available criteria wisely.
9 Common ESG Metrics
Commonly employed ESG metrics consist of both qualitative and quantitative metrics across all three categories of environmental, social, and governance factors.
3 Common Environmental Metrics
Environmental metrics measure the long-term ecological sustainability of a firm’s actions. These can be related to emissions, finite natural resources, and the environment, among other things.
Many of these metrics can be tracked on an aggregate basis or relative to other operating metrics (per capita, per unit produced, etc.).
• Emissions: Quantifies how much a firm emits in greenhouse gasses, or whether it’s working to reduce carbon emissions through its operations.
• Waste: Measures how much waste a company generates or recycles in their operations. Can also reflect a company’s impact on its surrounding ecology: e.g., air or water pollution.
• Resource Usage: Tracks the efficiency and extent of a firm’s operations when it comes to using energy, water, or other key resources.
3 Common Social Metrics
Social metrics evaluate how a firm’s policies impact its workforce, the community, and society at large. Attempts to quantify these metrics have largely been implemented on a per-occurrence basis, or as a rate over time.
• Human resources: Evaluates how a company treats its employees, gender pay gaps, diversity, frequency/magnitude of any workplace litigation, and employee turnover.
• Labor safety: Tracks a firm’s commitment to safe labor practices via metrics like frequency of workplace accidents and lost productivity.
• Product development and safety: Examines a firm’s product quality and sustainability through metrics like number of recalls, complaints, or even frequency of litigation. Can also be linked to environmental standards when it comes to how product inputs are sourced.
3 Common Governance Metrics
Governance metrics pertain to issues relating to business ethics, mitigation of agency risks, and transparency in reporting. These can be measured in terms of how executives are compensated, board policies, and accounting choices, among others.
• Ownership structure: Reviews how faithful a firm is to its shareholders when it comes to metrics like the number of independent directors on the board, or how voting rights are distributed between management and shareholders.
• Executive compensation: Measures executive compensation relative to industry standards or company profitability. Can also be tied to social concerns when measuring how compensation structures vary for different genders/minorities.
• Financial reporting: Tracks a firm’s accounting policies and how comprehensive and accurate they are. Could involve reviewing a firm’s books for key disclosures or frequency of one-off exceptions.
How Do Firms Report ESG Metrics?
To some degree, how each firm reports its ESG metrics depends on its policies regarding disclosures. But now companies do have some standardization for reporting climate-related risk factors and mitigation efforts.
Keep in mind, the adoption of ESG frameworks can vary widely by firm and disclosure of these metrics is still largely voluntary. Additionally, certain metrics may be difficult to quantify and, in some cases, management, stakeholders, or shareholders may disagree on the impact of certain ESG factors.
As a result, professional money managers sometimes may solicit the assistance of third-party ESG consultants to obtain an independent assessment of how a company actually performs on ESG metrics.
How Can Investors Use ESG Metrics?
Investors want to be discerning when investing in specific firms or funds that offer an ESG approach.
Given the range of ESG frameworks and the inconsistency in how frameworks are applied, investors should be aware that some firms may cherry-pick which ESG metrics they use. Investment funds and ETFs that offer an ESG-based approach may use their own proprietary metrics when deciding how to allocate ESG investments; which may make them difficult to compare.
When using ESG metrics, you’ll want to examine a company’s ESG-related disclosures closely to ensure that there’s consistency in the data being reported. Depending on the metric you’re examining, you may wish to avoid making comparisons across disparate industries and focus on identifying “best-in-class” investments for a single industry.
The Takeaway
Broadly speaking, ESG metrics can offer investors a useful dimension for evaluating certain types of sustainable investment choices. Although a unified set of ESG standards and metrics is a work in progress, there has been a steady push among regulatory bodies to establish ESG reporting requirements, here and worldwide.
As with any investment strategy, investors will want to manage their expectations appropriately and employ ESG metrics as part of a larger toolbox for investment analysis.
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