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1 1 (January 4, 2021)

handle is hein.crs/goveadn0001 and id is 1 raw text is: January 4, 2021 Introduction to Financial Services: Environmental, Social, and Governance (ESG) Issues ESG is a widely used acronymfor environmental, social, and governance is sues. Corporate governance-concerns about how companies should be managed-has evolved over time to include, arguably, a wider array of is sues that encompass ESG. Some consider ESG factors to be an integralpart ofdiscussions about sustainability. According to one definition, sustainability at the firmlevel is an approach that creates long-termshareholder value through managing opportunities and risks thatderive from economic, environmental and socialdevelopments. Over 3,000 signatories with over $103 trillion in as sets under management support Principles for Responsible Investment (PRI), a nongovernmental organization (NGO) that promotes sustainability through ESG. Although the UN initiated PRI in 2005, the six principles of responsible investment were launched at the New York Stock Exchange in 2006 with 100 initial signatories. Over the years, as moie signatories have joined PRI, they have increasingly asked investment managers to incorporate ESG factors in their investment decisions. In addition, state regulators, NGOs, and some Securities and Exchange Commission (SEC) commissioners and advisory groups have increasingly taken interest in ESG concerns. Congressionalinterest has centeredon what types ofESGdisclosures, if any, should be required. What i ESG? There is no universally agreed-upon defmition of what constitutes ESG. Investors and other stakeholders consider a wide-ranging array of topics as part of ESG. The discussion below on the characteristics and risks that can accompany ESG is not defmitive. It is meant to illustrate some of the perceived risks of either addressing or ignoring various ESG factors. Characteristics and Risks Fnvironmental. Investors and stakeholders may examine a firm's impact on the environment. Some consider the interaction with the environment to be a formof capital- the stock ofnaturalresources. Environmentalrisks include declining biodiversity; pollution; resource scarcity; and potential climate changeimpacts, including increasingly frequent and severe floods, hurricanes, and forest fires. For individual firms, ignoring environmental risks could potentially harmtheir reputations, endanger employees, and imperil physical operations, which could lead to costly litigation. For other firms and communities, addressing environmentalrisks might causeeconomic harm, with diminished access to natural resources andtheneedto either phy sically relocate or seek alternative production inputs at ahighercost anddiminished profits. https://crsrepo Social. Social factors encompass a firm's effects on its various stakeholders, such as consumers, employees, suppliers, contractors, and the local andbroader communities. Risks include potential infringementon the rights of others; gender- or ethnicity-based discrimination when hiring orpromoting employees; failure to monitor supplier and contractorpay; handling of customer datain a nontransparentand nonsecureway; political spending; and investing in projects or sectors that could be considered objectionable to specific segments of society. Companies that handle these risks poorly might experience effects similar to environmentalrisks, such as the inability to attract quality employees and exposure to costly litigation. In addition, some stakeholders might consider certain businessoperations or funding of certain entities in various areas to be unacceptable, including tobacco, gun manufacturing, private prison industries, abortion provideis, and gambling. On the otherhand, other stakeholders might consider an infringement of theirrights any limitations placed on their right to operate or fund such lawfulentities. Governance. A firm's self-governance and integrity when conducting business may raise questions. The policies, processes, andcontrols implementedby afirmhelp to define its self-governance and impact on various stakeholders. A fim's integrity is measured by whether it avoids corruption andbribery and engages with individuals and other firms that may pose a reputationalriskto the firm. If a corporation chooses not to address governance is sues, the associatedrisks could includeharmto its consumers and an environment leading to criminal activity and corporate reputationalharm, potentially resulting in firm failure. Firm failure negatively affects stakeholders- employees may losetheirjobs, suppliers might notbe paid, and localgovernments may receive less taxrevenue. Some examples are Enron (2001 bankruptcy), WorldCom(2002 bankruptcy), and MF Global(2011 bankruptcy). Recently, the fake account s candal at Wells Fargo Bankharmed its clients, resulted in the removalof many key executives, and prompted regulators to restrict the bank's growth. Materiality and ESG The disclosureof materialinformation is an important accounting principle. There is ongoing debate about what is material in determining which ESG factors a firm should target and disclose to investors. Discussion around what constitutes materiality is s imilar to discussion about what constitutes ESG-companies have discretionover what to include in both. Some proponents of ESG disclosure have stated that focusing on financial materiality would be most helpful to investors. .conress.ov 6

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