The ESG Index (ESGI) represents the three key spheres that encompass responsible investments (or “green investments”)—Environmental, Social, and Governance.
The responsible investments market has been rapidly gaining momentum in recent years, mainly in Europe and the United States. These investments are based mainly on the ESGI. The index’s primary users are investors attempting to predict, to the extent possible, the profitability of their investments in the long-range. This is based on the assumption a company’s commitment to ESG principles will contribute considerably to the company’s profitability in the short and long ranges.
Analyzing the ESGI is not merely for the purpose of investing in securities. It has also become a material consideration during acquisition transactions and likewise has an impact on a company’s image (and on the image of its officers).
Sustainability Indicators
The ESGI’s three spheres essentially constitute combined criteria for evaluating companies’ nonfinancial performance, i.e., companies’ activities in relation to topics that are vital to the company but not necessarily profitable. The basic assumption when evaluating commercial companies according to the ESGI is that large companies have corporate social responsibility and that they cannot operate for the sole goal of maximizing profits.
This is a fundamental change in trend that has been steadily gaining relevance and momentum. In order to satisfy the requirements of the ESGI, a company must fulfill every component in the following manner:
1. Environmental: The environmental criteria are perhaps the most prominent and talked about aspects. These criteria examine the way in which a company and its commercial conduct affect the environment and the planet. For instance, it examines if the company complies with regulatory requirements (permits, waste recycling, etc.) or regularly implements technological initiatives (the use of renewable energy).
2. Social: The social criteria mainly address a company’s internal conduct and examine the company’s policies towards employees, suppliers, and customers. These criteria address gender equality, human rights, eradicating discrimination, affirmative action, compliance with equal pay laws, work conditions, etc. Additional criteria examine a company’s social contribution to the community through charitable organizations or local and community volunteering. These criteria are very important since they are relatively easy to measure (and change). As a result, we might see significant progress within a relatively short time frame.
3. Governance: These criteria examine a corporation’s management practices and the conduct of its leadership. They include anti-corruption measures, diversity in management teams (representation of women and/or “disadvantaged” populations in key positions), executive remuneration, etc.
It should be noted, as detailed below, that corporations that fulfill the ESGI’s criteria more or less adequately must perform a long series of actions to receive the inherent benefits of fulfilling these criteria. Some of these actions are complex and require planning and implementation over the course of several years.
Global Trend
The pursuit of companies that fulfill the ESGI criteria is the result of two key factors:
- Progressive legislation.
- A new generation of investors.
Legislatures worldwide were initially motivated to take action in response to scientists’ persistent warnings about mankind’s destruction of the planet and climate change, and in response to the growing global awareness of the hardships of weak populations (child labor, water shortages in numerous countries, etc.).
The European Union, for example, one of the leaders in enacting legislation in this regard, drafted several regulations focusing on the ESGI. These regulations enable investment entities to examine companies according to their fulfillment of ESG criteria before investing in them.
In the United States too, the Securities and Exchange Commission advanced legal provisions that expand public companies’ reporting obligations relating to ecological aspects of their operations. These include the obligation to report the measures they are taking to reduce the company’s harmful impact on the environment. It is estimated that today, one out of every four dollars invested in the US capital market is aimed at ESG investments, and these numbers are expected to increase.
However, as mentioned above, it is not legislation driving this trend, but investors. This is a new generation of young, socially conscious investors who want to make sure the money they invest has no negative impact on society and on the environment. These new investors deem it important to ascertain whether their investments contribute to and are invested in companies that operate in a green and responsible manner. They emphasize environmental quality, employee rights, and women’s rights.
Officers’ Corporate Responsibility
One of the significant tools for advancing affirmative environmental and social action in companies is the imposition of responsibility on corporate officers since they govern the course of the corporation’s activities and are ultimately responsible for implementing reasonable measures to prevent environmental violations and to drive responsible environmental conduct.
The Israeli Companies Law contains several sections that impose obligations on corporate officers to manage a corporation’s activities with integrity: the duty of care, the fiduciary duty, and the determination that the actions of one organ in a company are tantamount to actions by that company. Israel has also enacted extensive environmental legislation that imposes specific, concrete responsibility on corporate officers for a company’s statutory compliance (such as laws for the prevention of various hazards and water laws).
These are basic regulatory obligations that mainly address violations and the imposition of criminal liability in respect thereof. However, legislation will also undoubtedly soon develop in the direction of encouraging companies to take action to improve their environmental and social performance.
Companies’ Exploitation of the ESGI for False Publicity
Everyone agrees the ESG principles are important aspects of companies’ activities. On the other hand, they have also received considerable criticism. This criticism is not directed toward the principles themselves. It is rather directed against companies that exploit these principles for the purposes of public relations. For example, the term “greenwashing” is a familiar term among investors. It refers to companies that spend more time and money on their image as being environmentally friendly and socially responsible than on actually being so. These companies publicize misleading information that exaggerates their environmental and social activities. They do so when, in fact, their ESG activities constitute token efforts and they are still polluters, old-fashioned, and not necessarily socially responsible.
Exploiting the ESGI for this type of deceit of consumers and investors is not a new trend. Third-sector organizations and even countries have faced exposure for using growing social and environmental awareness as a public relations and marketing tactic.
What’s the Situation in Israel?
As stated, this trend is gaining momentum in both the United States and Europe. It has the support of legislative and enforcement authorities (both in relation to securities and in relation to the regulatory requirements that every company must fulfill). In Israel, to date, the situation is slightly different.
Awareness is indeed growing. However, notwithstanding the fact Israel signed a variety of environmental accords, corporate responsibility is still not sufficiently developed in Israel. At the same time, it is evident Israel is also taking part in the environmental awakening. 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 the ESGI, these reports are still basically voluntary. That is to say, companies in Israel are not under any obligation to report.
ESG Index in Israel
Nevertheless, Israel does have indexes enabling investors to examine the environmental impact of the companies in which they invest. Such is the Environmental Impact Index of the Ministry of Environmental Protection or the “Maala” Index. It also issues regulations and legislation that impose obligations on companies and officers with regard to companies’ environmental and social impacts. In addition, in recent years, the Ministry of Environmental Protection has increased its enforcement measures. The ministry is also scrutinizing businesses’ and companies’ compliance with environmental legislation (air pollution, water pollution, licensing, etc.).
Undoubtedly, Israel is attempting to catch up with European countries and the United States. Recently, the Knesset’s Ministerial Committee for Legislation approved a climate change bill. The objective of this bill is to create an organizational framework for the State of Israel to contend with the climate crisis while emphasizing key aspects of the efforts needed on a national scale. These aspects focus, first and foremost, on minimizing and preventing greenhouse gas emissions according to targets and structured plans. These steps aim to ensure the State of Israel fulfills its commitments under the Paris Accords.
This legislation, coupled with global trends and the new generation of investors, will certainly contribute to the creation of a new investment style in Israel. A style that will be in line with the global trend and with the ESGI.
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Barnea Jaffa Lande’s regulation team is at your service for further corporate governance and ESG compliance questions and information.
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