ESG definitions in transition
The journey to consensus on ESG standards will not be easy, but social factors remain an important consideration for the real estate industry, says Prof Martin Zsarnoczky.
In a changing economic and legal environment, it is never easy to talk about future trends, and “new” definitions of our industry must be dealt with carefully.
In September, Stefano Spinaci, a policy analyst at the European Parliament’s Members’ Research Service, published Environmental, Social and Governance (ESG) rating activities: Commission proposal for a Regulation on their transparency and integrity.
According to the Commission, “the current ESG rating market suffers from deficiencies and is not functioning properly, with investors and rated entities’ needs regarding ESG ratings not being met and confidence in ratings being undermined. This problem has a number of different facets, mainly (i) the lack of transparency on the characteristics of ESG ratings, their methodologies and their data sources and (ii) the lack of clarity on how ESG rating providers operate. ESG ratings do not sufficiently enable users, investors and rated entities to take informed decisions as regards ESG-related risks, impacts and opportunities.”*
It is clear that something has gone wrong here, but how should ESG be represented in the theory?
ESG provides standards that stakeholders use to measure their impact on society and the environment. Social impact is one of the three pillars of ESG and refers to the positive or negative effects a company’s activity has on society.
The term social responsibility focuses on issues like being environmentally friendly and acting responsibly towards customers, employees and suppliers.
The responsible activities companies undertake because they want to “do the right thing” could be measured among all stakeholders. In general, stakeholders are encouraged to generate positive images concerning the company’s contribution to its prosperity.
Ethical issues
Very often, ethical issues are a crucial aspect of social responsibility. Customers are individuals who choose to consume products a business sells. Therefore, they need to know the purpose that drives the business. Offering initiatives like fair prices, sponsorships, scholarships, quality services and products is part of its ethical responsibility.
Such actions make the customers feel appreciated and happy.
In the industrial sector, ESG practices could involve reducing energy consumption and greenhouse gas emissions, implementing sustainable waste-management practices, ensuring safety and satisfaction through quality care and communication, or providing training and development opportunities for employee to promote job satisfaction and retention.
Source: Dr Martin Zsarnoczky and Dr Szergej Vinogradov
Staff members could also volunteer a few extra hours a week to do charitable work, demonstrating that the organisation as a whole is dedicated to helping others.
So, where is the contradiction? Dr Szergej Vinogradov and I carried out research in August this year that focused on how science can demonstrate a logical approach to ESG.
The Web of Science (WoS) is a pay-for-access platform that provides access to multiple databases that provide data from academic journals, high-quality publications, published theories, conference proceedings and other peer-reviewed documents in various academic disciplines.
Specifying ESG definitions
The first step was to specify the ESG definition of basic terms, descriptions, synonyms and possible related terms. After narrowing down the results obtained, the search could be extended to the entire WoS database. Our research goal was to see connections and similarities in other conceptual environments, which could be used to clarify the originality of ESG.
As can be seen in the image (above), we managed to identify keywords, links, connections, phrases and four separate clusters of similarities, measurable data points and further interactions.
It is apparent that it is not easy to determine the social variables of ESG, even after checking the best research ideas and work experience.
In general, the S in ESG refers to the social or societal factors and considerations that are relevant to evaluating the sustainability and ethical impact of a business, investment or organisation, showing how a company or entity interacts with and affects people, communities and society as a whole.
Social factors are a critical component of ESG analysis and are used to assess a company’s social responsibility and impact on various stakeholders. Social factors in ESG can include, but are not limited to, the following:
- labour practices and human rights
- diversity and inclusion
- community engagement
- product safety and quality
- customer relations
- supply chain management
- ethical governance
- employee benefits and well-being
- stakeholder engagement
- social impact and sustainability initiatives
What is at stake in the real estate industry at the moment?
In project financing, current high interest rates make it more expensive to borrow money for property purchases. The rising cost of construction materials and labour can significantly impact the service real estate market.
In the demand and supply correlation, slowing market dynamics play a crucial role. Unaffordable housing is a major challenge in the EU that leads to homelessness, financial insecurity and inadequate housing.
Predictable solutions
Two ‘social’ responses, impact investing and responsibility, seem to be the predictable solutions.
Social impact investing refers to providing capital to companies, organisations and funds that are focused on solving critical societal or environmental problems. Social impact investing involves actions and activities that give back to society, or make companies operate fairly. The business process should follow public authorities’ and customers’ new expectations of, and concerns about, change in the industry.
Social responsibility includes the idea that investors should balance profit-making with activities that benefit society. In the near future, more companies could find their motivation shifting from a focus just on profit, to a mix of bottom line and social responsibility actions. This could also motivate their consumers to purchase their goods and services.
This is a two-way interactive process with expectations and rising social standards that could influence the investment choices of institutions, individuals and investors.
Economic, social and political momentum is on the side of EU policymakers seeking to reach an agreement on ESG standards, but the journey to convergence will not be easy. ESG considerations are not limited to environmental protection alone. Affordability is expected to play a bigger role than any other social impact.
Social factors such as social impact, social responsibility, community engagement, employee welfare and diversity and inclusion are also important components of ESG. While the real estate industry is facing a crisis caused by the after-effects of the pandemic and ongoing high inflation, ESG considerations remain a high priority.
Incorporating ESG factors in strategic decision-making can mitigate unforeseen challenging trends and create a positive impact, even long-term value, for investors, and tenant demand at the same time.
Martin Zsarnoczky is an associate at Multiple Impact, the advisory and management firm, and a professor at WSG University of Economy
