ESG stands for environmental, social and governance. It is a broad framework for considering a company’s environmental impacts and risks, its relationships with people and society, and how it is directed and managed. ESG is not one universal score, checklist, or guarantee that an investment is sustainable.
What do the three ESG pillars cover?
The categories organize questions about an organization and its activities. Their boundaries can overlap: for example, governance processes may determine how a company responds to environmental or social concerns.
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Environmental
This pillar concerns an organization’s effects on the environment and environment-related risks and opportunities. Topics can include climate change mitigation and adaptation, biodiversity, pollution prevention, and the circular economy. The European Commission outlines these areas in its overview of sustainable finance.
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This pillar covers a company’s relationships with people and society. Examples include inequality, inclusion, labor relations, human rights, and investment in people, skills, and communities.
Governance
Governance concerns how an organization is run, including its management structures, employee relations, and executive compensation. It can also shape whether and how environmental and social matters are considered.
How is ESG used in investing?
Investors may consider ESG factors alongside other information when evaluating companies, investments, or portfolios. The label alone does not tell you which factors an investment considers or how much weight it gives them. The U.S. SEC’s Investor.gov notes that investments can use different criteria and weight the pillars differently; an investment may also incorporate ESG factors without using “ESG” in its name. See its ESG investing explanation.
ESG is not synonymous with sustainable investing, nor does an ESG label by itself establish that an investment produces positive environmental or social outcomes. To understand a particular fund or investment, check what it measures, what it excludes, and how it uses the information.
Why can ESG ratings differ?
An ESG rating is an assessment, not a universal measurement. The European Commission explains that ratings may assess a company or financial instrument’s sustainability performance through exposure to sustainability risks, impacts on people and the environment, or both. They may cover all three pillars or only selected factors and subfactors, and may use analyst judgment or data analysis. Different ratings can therefore reach different results without measuring the same thing.
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When comparing ratings, look for:
- Coverage: Which companies or financial instruments are included?
- Factors: Which pillars and specific issues are assessed?
- Perspective: Does the rating focus on financial risks, real-world impacts, or both?
- Evidence and method: How are data gathered and assessments made?
- Weighting: How are factors weighted and combined into an overall assessment?
The criteria and methodology matter more than treating a score as a standalone verdict. The Commission’s overview of ESG rating activities describes this variation in scope and approach.
How is ESG different from a reporting standard?
ESG is a general label; a reporting standard sets a more specific disclosure purpose and scope. IFRS S1, for example, requires disclosure of sustainability-related risks and opportunities that could reasonably be expected to affect an entity’s cash flows, access to finance, or cost of capital over the short, medium, or long term. Its disclosures are organized around governance, strategy, risk management, and performance, including progress toward targets.
The IFRS Foundation issued IFRS S1 in June 2023. It is effective for annual reporting periods beginning on or after 1 January 2024, with earlier application permitted alongside IFRS S2. These requirements describe a particular reporting framework; they do not create a single all-purpose ESG score or definition. Details are available in the IFRS S1 standard summary.
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For the European Union, Regulation (EU) 2024/3005 on the transparency and integrity of ESG rating activities entered into force on 1 January 2025 and applies from 2 July 2026, according to the European Commission. It addresses transparency about rating objectives and methodologies and provides for relevant providers serving investors and companies in the EU to be authorised and supervised by ESMA. Applicability depends on the regulation’s scope and circumstances; consult the current legal text and appropriate local guidance for compliance questions. The Commission’s ESG ratings page provides its overview.
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