The Journey of ESG: What Brought Us Here and Where Are We Headed?

Introduction

The importance of the Environmental, Social, and Governance (“ESG”) management model is increasing because of its relevance to modern business and investment practices, emphasizing a comprehensive approach to sustainability and the importance of businesses’ impact on society. ESG emerged from the growing awareness of good corporate governance in the early 2000s following the Enron and Worldcom scandals. While the goal of corporate governance was to protect shareholders’ and creditors’ rights in the course of maximizing company profitability, ESG’s focus has expanded to encompass a wider group of stakeholders including employees, customers, subcontractors, suppliers, and more, while at the same time embracing environmental considerations. As ESG evolved, the concepts of corporate social responsibility and sustainable development became its primary goals.

The United Nations “Global Compact” initiative was a pivotal moment in the evolution of ESG in that it began the process of institutionalizing ESG frameworks by urging businesses to adopt sustainable practices on a voluntary basis. The “Global Compact” envisioned companies embracing a management approach that considered all stakeholders (not just shareholders) within a wider context and integrating the environmental considerations impacting these stakeholders and society at large. The term “ESG” gained formal recognition in the 2004 United Nations Global Compact report “Who Cares Wins,” which underscored the financial relevance of ESG factors.

Over the past two decades, ESG has rapidly evolved, driven by increasing regulatory requirements, investor demand for responsible investing, and growing evidence that ESG integration can enhance financial performance. The rise of global challenges such as climate change, social inequality, and corporate governance scandals has further cemented ESG as a critical lens through which companies and investors assess risk, opportunity, and long-term viability. Today, ESG considerations are being embedded in corporate strategies and decision-making as well as regulatory frameworks, overall reflecting a comprehensive approach to achieving sustainable and inclusive growth.

ESG Pillars

ESG is based on three major pillars.  Among the three, governance is maybe the most familiar pillar. The “G,” which stands for good governance, was in fact the starting point of discussions concerning ESG. Good governance aligns closely with the four core principles of transparency, fairness, responsibility, and accountability. That said, until the concept of ESG was introduced, the corporate governance model was a more inward-looking approach, especially with respect to responsibility and accountability. After the adoption of ESG principles, companies now need to embrace an outward-looking approach.

The second pillar of ESG is the “S,” which refers to the social element. It is concerned with the social rights and welfare of a broader range of stakeholders, of which, employees tend to be the group most exposed to the impact of business practices. The UN’s Guiding Principles on Business and Human Rights was an influential milestone in the development of the social pillar of ESG. The Guideline focused on shaping the relationship between companies and employees from a human rights perspective, detailing how businesses should observe these rights. The social factor kicks in within the context of a company’s relationships with its employees, suppliers, customers, communities, and involves assessing aspects such as labor practices, human rights, and corporate social responsibility. The liability of companies and their executives in this respect will depend on whether they treat the wider stakeholder group in accordance with human rights. Therefore, it requires companies and executives to focus on the internal systems and controls that govern their company, including executive leadership, audits, internal controls, and stakeholder rights.

Finally, the last pillar, “E,” represents the environment. Its goal is to guide companies in ways to prevent environmental harm and maintain ecological balance. The environmental pillar requires companies to consider how they manage their ecological footprint, including energy use, waste, pollution, and resource conservation efforts. To that end, the European Union (EU)’s transformative Green Deal stands out as shaping the near future of the environmental aspects of ESG. It outlines how the carbon footprint generated by corporate activities from their production and the provision of services will be zeroed out. Initially targeting a 55% reduction in carbon emissions by 2030 from the time the document entered into force, the ultimate goal is to achieve complete carbon neutrality by 2050. The EU has further bolstered this initiative with a series of directives, facilitating reporting mechanisms and actively monitoring progress. The EU aims not only to mitigate climate change within its borders, but also to have a broader impact through measures like the carbon footprint mechanism at its borders. This system governs the EU’s imports and trade with trade partners, and involves an emission trading system for the domestic market. The EU backed up its carbon footprint reduction measures with a corporate governance reporting directive that took effect in January 2023, which requires companies to prepare sustainability reports.

By integrating ESG criteria into the decision-making process, companies and investors aim to enhance long-term value creation, mitigate risks, and contribute to sustainable development goals. This comprehensive management model helps identify ethical and sustainable investment opportunities and promotes transparency, accountability, and ethical behavior in the corporate world. Ultimately, ESG aims to create a balanced approach where economic growth, social equity, and environmental sustainability lead to a more resilient and inclusive global economy.

What Lies Ahead?

We will soon experience the effects of European Union ESG regulations on Türkiye and Turkish companies. Approximately 40% of Türkiye’s exports are destined for the European Union, and carbon footprint regulations mandate compliance by third-party companies doing business with member countries (i.e., Turkish exporters). Several sectors, including iron, steel, aluminum, cement, fertilizer, hydrogen, and energy, are expected to contend with rising production costs. Therefore, Turkish companies will have to integrate the ESG management model more effectively into their activities over the next two years to avoid incurring financial losses.

From a global perspective, as challenges such as climate change, social inequality, and other corporate governance issues increasingly impact societies and economies, the ESG management model will inevitably become central to corporate strategies and investment decisions. The integration of advanced technologies such as artificial intelligence, blockchain, and big data analytics will enable more precise measurement and management of ESG performance, enhancing transparency and accountability. As a consequence of more stringent regulatory frameworks and mandating comprehensive ESG reporting and compliance, companies will be driven to adopt more sustainable and socially-responsible practices.