Introduction
The prevailing notion is that "environmental, social, and governance" (ESG) awareness is not measurable. While some aspects of this conduct are embodied in law, much of it is internal. It's also a state of mind, and it shapes the organization's persona. It reflects conduct to show that companies value the environment, are law-abiding, and are responsible for their employees.
This article will show, however, that ESG standards have evolved to be measurable and become an integral component of due diligence.
Environmental (E) refers to the corporation's responsibility to reduce carbon emissions, conserve natural resources, and to adopt practices that reward the use of renewable energy and the reduction of waste.
The social (S) component is a commitment to promote diversity and inclusion in its employment policies. It means the company follows fair labor practices, supports local communities through social initiatives, and prioritizes the health and safety of employees and customers.
Governance (G) is a mandate to maintain transparency, be ethical and to obey the law.
Positive ESG attitudes have commercial value because they are a signal to consumers and investors. Collectively, they show that an enterprise has a purpose beyond profitability and that the enterprise aligns its commercial pursuits with broader social and environmental good practices.
A due diligence assessment, conducted by investors within the ESG framework, evaluates the degree to which a company recognizes and fulfills its ESG responsibilities.
ESG evaluation
Decision No. 167/QD-TTg and Circular No. 13/2023/TT-BKHĐT aid private sector enterprises to follow positive business practices. The Sustainable Business Model Assessment Toolkit (SBMAT) creates a defined set of criteria, each assigned a specific weight. These criteria are utilized to assess the degree to which an enterprise implements these positive practices. Details are discussed on the Agency of Enterprise Development (AED) under the Ministry of Industry and Trade (MOIT) at: https://esg.business.gov.vn/evaluate.
Briefly, the SBMAT is divided into two primary sections: in Part 1 generic enterprise information is gathered; in Part 2, sustainability is measured and evaluated.
In Part 1, enterprises provide facts such as size, primary production, industry focus, and more.
In Part 2, enterprises provide details on how they interact with the environment, and what their internal Social, and Governance policies are. These practices are then scored.
Environment includes adherence to environmental standards; management of materials, energy, and water; biodiversity (using certified sustainable materials, avoiding products sourced from endangered species); emissions, wastewater disposal or treatment; waste management; and other responsible practices.
Social includes employment practices and more: employee relations, occupational safety, education, diversity, equal opportunity, participation in unions, child labor, forced labor, civil rights, community engagement, social standards for suppliers, customer health and safety, and marketing practices.
Governance looks at ESG implementation, the structure, functions and performance of the board of directors, stakeholder engagement, transparency, shareholder rights, and a multitude of governance-related practices.
Once the business submits its inputs, the SBMAT gathers the data and generates a table with ESG scores.
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ESG is no longer voluntary – negative actions have consequences
ESG is a snappy term that signals that a corporation's responsibility can not only help its own profitability and convenience but extends further into the community and society at large. Companies are expected to reduce emissions, engage with the community, ensure ethical governance, be desirable employers, optimize supply chain management, and accurately report ESG performance.
ESG actions are gradually mandated nationally and worldwide. For these reasons, investors have begun to take a target company's ESG practices into account.
For example, starting in 2026, under the Carbon Border Adjustment Mechanism (CBAM), importers of goods into the EU will have to monitor and report the carbon emissions associated with imports. During the CBAM transitional period, from 1 October 2023 until 31 December 2025, EU importers of specific goods such as cement, iron and steel, aluminum, fertilizers, electricity, and hydrogen must submit quarterly emission reports that relate to these imports. A significant portion of these products originate from Vietnam so Vietnam exporters will have to adjust their practices to remain competitive. Failure of EU importers to report can result in penalties ranging from EUR 10 to EUR 50 per tonne of unreported emissions.
Decree No. 06/2022/NĐ-CP and Decision No. 01/2022/QĐ-TTg, effective from January 18, 2022, names 1,912 established entities whose activities involve natural resources and environment, construction, transportation and in the industrial and trade sectors. These entities must conduct periodic greenhouse gas inventories. The purpose of the inventory is to determine Vietnam's progress to reach greenhouse gas (GHG) net-zero emissions by 2050.
Under Vietnam's recently amended Law of Environment Protection, manufacturers and importers of all products and goods must now exercise "extended producer responsibility (EPR)" towards the environment. There is now a level of responsibility throughout each stage of a product's life cycle: design, production, consumption, and disposal. This means there is a need to take affirmative steps to minimize environmental harm. The steps include promoting resource-saving designs, reducing waste, recycling, and managing disposal. These regulations apply to manufacturers and importers' responsibilities.
Specifically, under Decree 08/2022/NĐ-TTg (Decree 08), beginning January 1, 2024, manufacturers and importers of packaging, battery products, lubricants, tires, and tubes must now recycle a certain ratio of the products. For example, manufacturers of rigid PET packaging must recycle 22% of their packages and use the recycled products as raw materials for others in PE fibers manufacturing. This requirement will extend to electrical and electronic products from January 1, 2025, and on January 1, 2027, vehicles will be added.
Also, under Decree 08, manufacturers and importers must either themselves recycle, including registering recycling plans and reporting recycling results to a designated agency, or they will have to pay a certain sum to the Vietnam Environmental Protection Fund and allow it to manage the recycling processes for them. Failure to comply or to meet standards will result in penalties and remedial measures.
As described in Article 4 of Decree No. 45/2022/NĐ-CP, an organization or individual that commits an administrative environmental protection offence is liable to several penalties up to VND 2,000,000,000, suspension of environmental license, suspension of operations, and more.
Internationally, companies face increased pressure from shareholders to link executive compensation to ESG outcomes. In particular, there is a trend to include ESG metrics in executives' long-term incentive plans.
Disregard for ESG standards can lead to negative consequences
In April 2016, Formosa Ha Tinh Steel Corporation, a subsidiary of Formosa Plastics Group, caused a significant environmental catastrophe in Vietnam. The company discharged toxic chemicals from its steel plant in Ha Tinh province into the ocean, resulting in severe harm to local fisheries, coastal communities, and marine ecosystems. Formosa's conduct impacted thousands of livelihoods and ignited nationwide outrage. The government imposed a US$500 million fine on the corporation and required extensive cleanup and compensation efforts.
At that time ESG standards, as they are known today, were weak or nonexistent. Today, ESG standards are much clearer, and failing to take them into account can expose companies to legal liabilities, fines, lawsuits, a mandate to cure, and regulatory sanctions.
Formosa's conduct was seen to be criminal, deliberate and provocative. In today's increasing public awareness, even a less serious infraction can expose a company the government to sanctions.
Without public understanding and expectation of ESG scores, negative consequences would have less impact. ESG scores measure a company's performance and good citizenship in a way that the public easily understands. Weak scores will affect companies negatively. Maintaining public awareness of the meaning and significance of ESG scores will ensure that companies are held accountable for their environmental, social, and governance practices.
Stated differently, disregarding ESG standards can result in a negative reputation and a loss of trust from customers, employees, stakeholders, investors, and the wider community. The hope is that companies will be motivated to be ESG-compliant.
Mercedes-Benz and several other major car manufacturers are facing a class-action lawsuit in the U.S. over diesel emissions "cheating". The companies are alleged to have installed a "diesel gate" software in their cars to bypass emissions tests.
In 2015, Volkswagen faced a similar lawsuit. The German car manufacturer was said to have programmed emission controls on their diesel vehicles which caused the vehicles' NOx output to falsely meet US standards during regulatory testing. However, those vehicles were found to have emitted up to 40 times more NOx in real driving. The scandal has cost Volkswagen $33.3 billion in fines, penalties, financial settlements, and buyback costs.
In summary, the aftermath of an ESG-ignorant or careless attitude can be financially catastrophic. Beyond immediate legal and regulatory penalties, companies suffer long-term damage to their brand reputation and market value.
These cautionary examples emphasize the change in public attitudes. ESG awareness and compliance by companies and due diligence investigation by investors are no longer an afterthought. By integrating a company's ESG compliance into investment decisions, investors both manage and enhance the potential for sustainable and profitable outcomes.
ESG due diligence process
ESG due diligence is an evaluation of a target company's ESG opportunities, performance, and risks. The process involves several stages: (i) identifying potential ESG risks and opportunities, (ii) evaluating and prioritizing the ESG issues that matter most, and (iii) integrating the information to facilitate the investment decision.
- Identifying potential ESG risks and opportunities before a decision is made
Investors can and should first study public information, such as the target company's sustainability reports, related legal matters, and media coverage to assess its ESG track record and reputation.
In 2024, for example, Coca-Cola Vietnam set up 39 systems for students and school communities to access clean water. In a parallel initiative, Coca-Cola increased its use of refillable bottles and collected packaging for recycling through a program called World Without Waste. Such programs were met with broad public approval.
Hong Kong International Airport addresses social issues through various initiatives. In a creative move, Hong Kong International Aviation Academy offers people from all walks of life an opportunity to work in the aviation sector and provides training programs to upskill not only its staff but all who volunteer, thereby building a deep talent pool for the industry.
Investors can gather ESG performance data on the target company by collaborating with its internal and external stakeholders, members of the management board, employees, suppliers, and industry experts. They can easily find ways to sample internal opinions.
ESG due diligence can uncover opportunities to create value through innovation, and market differentiation. Investing in companies that, for example, cut waste, and use resources efficiently can boost profits. Investing in companies with fair labor practices can help investors avoid labor unrest and attract and retain more talent. Investing in companies with ethical supply chains can foster robust supplier relationships, project transparency, and clear track records, enabling stakeholders to ensure adherence to standards.
- Evaluating and prioritizing the ESG issues that matter most
Investors need to identify those ESG issues relevant to the target's industry. For example, for a steel mill, employee satisfaction may be important but clean waste disposal may be critical. Making such a judgment helps investors to determine which ESG factors have the largest impact on the company's financial performance, reputation, and its stakeholder relations. They can then assess whether the allocation of resources and effort addresses the critical areas.
In another example, if investors target a company that operates in the technology sector, and that provides online services and collects users' data for advertising and analytics, then data privacy and security are critical ESG issues. Failure to protect user data could result in costly data breaches, regulatory fines and lawsuits, impacting the company's reputation, profits and shareholder value. Due diligence examination must include an assessment whether there are robust data privacy and security measures in place.
- Integrating information to facilitate the investment decision
Findings from an ESG due diligence review are important markers. They can alert one to vulnerabilities that can affect future financial performance and reputation, or they can give comfort.
Conclusion
ESG continues to evolve.
ESG is no longer a peripheral consideration; it has become a central priority. Increasingly, companies are obliged to take initiatives to balance ESG goals, short-term financial requirements and long-term benefits. Negative ESG factors can tarnish the company's reputation, leading to potential media-driven boycotts and profit loss. The public, employers, customers, and governments now take it seriously.
There is a cautionary note against "greenwashing". While ESG might receive favorable media attention, there's concern that it could be used as a tool for look-good press coverage. It's too early to tell whether ESG will bring about genuine change or just a greenwashing tactic. To avoid this outcome, the public, media, and the companies themselves must take ESG seriously to ensure it leads to authentic improvements.
In summary, the ESG principle is not just a checkbox in a business transaction. It stands as a critical factor to shape the future success or failure of a business. Investors must integrate ESG elements into the decision-making process.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.