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UNDERSTANDING ESG FRAMEWORK

Most investors focus on the profit generating ability of a business to make investment decision. However, over the last few years, the societal discussions about companies and businesses have also started focusing on sustainable development, and corporate social responsibility. 
This has given traction to investment theme that is focused on Environment, Social and Corporate governance (ESG). Initially this framework was used by handful of “Impact” investors. But this framework has gradually gained traction as these frameworks also provide commercial value.

Under this framework investors evaluate companies based on these criteria:
(i) How does the company’s activities affect the environment? Companies with low carbon emission and low contributors to pollution rank better than others. 
(ii) What are the activities that the company perform in terms of social development? This includes focus on human rights, gender equality and many such social factors. Companies that contribute more to these factors rank better than others. 
(iii) The last criteria focus on corporate governance standard followed by the company.
ESG investors use the ESG filter to short list their potential investment. Once short listed, the stock does not become an automatic investment. Investors perform all the other regular analysis to identify suitable investment. 

Although ESG framework appear to be more focused on ethical criteria than financial criteria, the proponents of the framework cite several financial advantages that can accrue to companies following ESG framework:

(i) Companies focused on environment face minimum disruption on account of regulatory intervention of environmental activism. 
(ii) Companies working towards social cause generate positive recall value in the society which can make it easy for them to recruit employees and attract customers. 
(iii) Sustainable production process can lead to less cost on account of power consumption or water usage. 
(iv) Strong corporate governance practice reduces risk perception and in turn reduces the cost of capital for that organization.

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