ESG as a tool for achieving sustainable development and strategic business goals

Exploring the concept of ESG further, this publication proposes to distinguish between the concepts of ‘sustainable development’ and ESG, to find out their correlation, and to identify arguments for the extent to which it is appropriate to consider ESG factors in a company’s long-term strategy.

Correlation of the concepts of ‘sustainable development’ and ESG

The concept of ‘sustainable development’ began to develop in the late 60s and early 70s (different sources note different dates of the first appearance of this term). In contrast, the official emergence of the ESG concept is associated with the report ‘Who Cares Wins’, developed by key global financial institutions under the auspices of the United Nations in 2004, which justifies the importance of taking into account and analysing ESG factors in the company’s activities in the investment process.

Since then, the ESG concept has gradually evolved into legal and regulatory requirements. For example, in 2014, the EU introduced an obligation for large public interest entities to report on their environmental, social, human rights, anti-corruption and bribery activities. In 2019, the terms of the ESG concept were already being applied at the level of EU legislation.

At this stage, the concept of ‘sustainable development’ has already gained some clarity in the Ukrainian regulatory environment:

• Ukraine’s Sustainable Development Goals for the period up to 2030 have been defined, which duplicate the global Sustainable Development Goals for 2030 proclaimed by the UN General Assembly;
• sustainable development is established as one of the principles:
  – of the state climate policy, which is to ensure that the state climate policy is in line with the United Nations global sustainable development goals by ensuring a balance between environmental, economic and social aspects;
  – state regional policy, which is the development of society to meet the needs of the present generation while taking into account the interests of future generations;
• the term ‘sustainable energy development’ is defined as a component of sustainable development which ensures a continuous and purposeful process of positive changes in the social and economic situation, reducing the negative impact on the environment and climate as a result of improving energy efficiency and replacing energy from fossil sources with renewable energy sources;
• directions for the formation and implementation of state policy in the field of reporting on the sustainable development of enterprises based on common methodological principles adopted in EU member states were determined;
• joint-stock companies are recommended to use the Annex on Corporate Governance and Sustainable Development in the Corporate Governance Code approved by the National Securities and Stock Market Commission.

At the same time, the integrated implementation of the ESG concept elements in Ukrainian legislation is only beginning, and specific aspects of the E-, S- and G-components of this concept are regulated in various regulations at different levels.

The relationship between the concepts of sustainable development and ESG is a connection between the general and the particular, where ‘sustainable development’ is a general concept that provides a vector for decision-making at the level of international cooperation and public and business management.

In turn, the ESG concept is usually seen as a separate approach to assessing and disclosing the results of investments or the environmental impact of a company’s activities, which aims to achieve sustainable development goals in aggregate and on a global scale.

What is the impact of ESG?

The undeniable argument for reflecting the ESG concept and its components in a long-term business strategy is its impact on

Investment

The investment attractiveness of a project (bankability) includes financial indicators and indicators that will indirectly affect the project implementation. Critical for investors (creditors) when deciding whether to provide financing is the project company’s consideration of ESG factors in its activities, the availability of an ESG strategy and its positive assessment by a potential investor. Therefore, companies are joining ESG ratings and ESG transparency indices, which indicates the demand for tools to verify the company’s ESG measures and policies.

Participation in the value chain of a product or service

The company’s activities are not isolated, and, for example, production depends on the supply of raw materials, supplies and other goods, provision of services and performance of works, i.e. on interaction with a significant number of counterparties. Therefore, the field of chain interactions should also be considered when assessing ESG factors and developing ESG strategies.

Such requirements are already being introduced into legislation in various countries. In particular, in the EU, a company’s sustainability reporting must include information on both its operations and its value chain – the company’s products and services, business relationships and supply chains, both within the EU and information from foreign countries if the company’s value chain extends beyond the EU.

Environmental taxation

Reducing the impact of companies on climate change through economic restrictions on greenhouse gas emissions is the basis of the E-component of the ESG concept. The tools used to achieve these goals include the limitation of greenhouse gas emission quotas, selling permits for off-limit emissions (a system of trading in greenhouse gas emission permits) and environmental taxation.

It is essential to remember that countries and regions that impose a significant economic burden on resident polluters also require no less effort from foreign counterparties. For example[1], CBAM is an example of a regulatory instrument introduced to impose an additional financial burden on foreign companies whose activities are potentially associated with significant greenhouse gas emissions and which seek to import products to the EU.

Accordingly, assessing the company’s internal production processes, inputs, raw materials, and products and implementing tools to reduce greenhouse gas emissions in producing goods will reduce the tax burden on the company.

ESG’s reputation as a competitive advantage

When buying goods or services, consumers also consider the company’s efforts to implement the ESG concept. A company’s positive public reputation usually increases its customer base.

As an example, the public demand for clean energy, which is one of the decarbonisation measures, has led to the emergence of a separate economic instrument in the form of guarantees of origin, which, as a part of a specific type of energy (e.g. electricity or gas), certifies the source of its origin (e.g. renewable energy sources: wind, solar energy, etc.). In other words, electricity from a renewable energy source includes an additional cost – the cost of a guarantee of origin. Companies can use guarantees of origin to certify the use of energy from renewable sources in their operations as part of their ESG activities.

In addition to commercial reputation, ESG also affects a company’s reputation as an employer. This reputation is largely shaped by implementing social (S) ESG measures. Still, a company’s environmental awareness and corporate governance image (effective anti-corruption measures, sustainable management practices and communication) are becoming increasingly important to employees, especially among the younger generation. More and more employees are considering the business practices of their potential employer when choosing a job.

The ESG concept is, therefore, closely linked to sustainable development, as it offers tools for integrating environmental, social and governance risks into business strategies. Implementation of ESG principles allows companies to meet modern challenges and create long-term value for society, investors and the environment.

If you would like to discuss the issues raised in this paper in more detail, please contact the SK team.

Information contained in this legal alert is for general informational purposes only, does not constitute legal or other professional advice and should not be relied upon as a substitute for specific professional advice adapted to the specific circumstances.

[1] The CBAM will be applied in its final regime from 2026, while the current transitional phase runs between 2023 and 2025