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1 1 (January 13, 2022)

handle is hein.crs/govegfr0001 and id is 1 raw text is: Congress&onaI Research Servt informing Ih Iegislaive dIbate soc 1914 Updated January 13, 2022 Introduction to Financial Services: Environmental, Social, and Governance (ESG) Issues ESG is a widely used acronym for environmental, social, and governance issues. Corporate governance-concerns about how companies should be managed-has evolved over time to include, arguably, a wider array of issues that encompass ESG. Some consider ESG factors to be an integral part of discussions about sustainability. According to one definition, sustainability at the firm level is an approach that creates long-term shareholder value through managing opportunities and risks that derive from economic, environmental and social developments. Over 4,000 signatories with over $120 trillion in assets under management support Principles for Responsible Investment (PRI), a nongovernmental organization (NGO) that promotes sustainability through ESG. Although the United Nations 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 more 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. Congressional interest has centered on what types of ESG disclosures, if any, should be required. What Is ESG? There is no universally agreed-upon definition 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 definitive. It is meant to illustrate some of the perceived risks of either addressing or ignoring various ESG factors. Characteristics and Risks Environmental. Investors and stakeholders may examine a firm's impact on the environment. Some consider the interaction with the environment to be a form of capital- the stock of natural resources. Environmental risks include declining biodiversity; pollution; resource scarcity; and potential climate change impacts, including increasingly frequent and severe floods, hurricanes, and forest fires. For individual firms, ignoring environmental risks could potentially harm their reputations, endanger employees, and imperil physical operations, which could lead to costly litigation. For other firms and communities, addressing environmental risks might cause economic harm, with diminished access to natural resources and the need to either physically relocate or seek alternative production inputs at a higher cost and diminished profits. Social. Social factors encompass a firm's effects on its various stakeholders, such as consumers, employees, suppliers, contractors, and the local and broader communities. Risks include potential infringement on the rights of others, gender- or ethnicity-based discrimination when hiring or promoting employees, failure to monitor supplier and contractor pay, handling of customer data in a nontransparent and nonsecure way, 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 environmental risks, such as the inability to attract quality employees and exposure to costly litigation. In addition, some stakeholders might consider certain business operations or funding of certain entities in various areas to be unacceptable, including tobacco, gun manufacturing, private prison industries, abortion providers, and gambling. On the other hand, other stakeholders might consider an infringement of their rights any limitations placed on their right to operate or fund such lawful entities. Governance. A firm's self-governance and integrity when conducting business may raise questions. The policies, processes, and controls implemented by a firm help to define its self-governance and impact on various stakeholders. A firm's integrity is measured by whether it avoids corruption and bribery and engages with individuals and other firms that may pose a reputational risk to the firm. If a corporation chooses not to address governance issues, the associated risks could include harm to its consumers and an environment leading to criminal activity and corporate reputational harm, potentially resulting in firm failure. Firm failure negatively affects stakeholders- employees may lose their jobs, suppliers might not be paid, and local governments may receive less tax revenue. Some examples are Enron (2001 bankruptcy), WorldCom (2002 bankruptcy), and MF Global (2011 bankruptcy). Recently, the fake account scandal at Wells Fargo Bank harmed its clients, resulted in the removal of many key executives, and prompted regulators to restrict the bank's growth. Materiality and ESG The disclosure of material information is an important accounting principle. The notion of materiality is at the center of SEC-regulated disclosure requirements. Materiality is deemed to be information that a reasonable investor would deem important in determining whether to purchase a security. In the ESG realm, there is an 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 similar to

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