ESG Reality Check Cheat Sheet
10 Things to keep in mind (and point out to those who don't get it or seem to want to)
We are continuingly amazed these days about how ESG has become an adjective (see last week’s post: ESG Investing, Just Stop It, for example). There seems to be increasing confusion in the discourse about all things ESG, Sustainability and Impact, so I thought I’d write a short, handy, cheat sheet on what’s really happening, which you can feel to use yourselves as a reference and to pass on to those who seem perhaps understandably confused with thanks to the excellent Julie Segal for pointing out this truly ridiculously titled Toronto Globe & Mail piece “ESG is facing a political and market backlash. Will it survive?” they ask breathlessly…
And so the 10 things to keep in mind are
ESG are issues, and not a single thing. These issues include environmental considerations such as air pollution, biodiversity, rainforests, the health of the oceans, and yes, of course, climate change and ongoing carbon emissions, embedded mostly in supply chains and are informed directly by the aggregate of people’s choices (including who they vote for and what they consume). Social issues include things like working conditions, diversity and inclusion, war and peace conditions, supply chain social auditing and so on, and governance issues include considerations such as can you trust your money to the companies you have invested in. These are a series of risks and opportunities. Please stop calling ESG a thing as if it is a single thing - it’s not one thing. Why would you invest in Asia, already something like half the world’s economy, without considering governance? That would be the provenance of fools and a failure from a fiduciary duty perspective. Pushback on considering ESG as a single thing as a result should be a non-starter, especially as such considerations increasingly are, as they should be, becoming fully embedded by a majority of financial institutions and asset under management more generally. How are US state attorneys general supposed to tell who is doing what as ESG considerations become embedded? And besides isn’t this supposed to be a free country?
Sometimes ESG data can help, but not always. ESG data will never tell you who will win the race to create the driverless, electric car and truck. (No big deal, that’s only the largest component of the US carbon footprint.) Nor is ESG data particularly helpful when considering transitions among electric utilities (the other of the largest two components of the US footprint) or oil and gas companies (who pretty much all look the same from a normalized carbon footprint perspective) or financial institutions for that matter. (Why would ESG data providers ever want to criticize their clients? Or so they have told me a number of times, but that’s another story). ESG data is useful as a potential red flag indicator, on issues of potential concern across all ESG subcategories, which when these issues manifest, can destroy company value, especially intangible value, or what we call the plus in ESG+ in our new framework for index provider CSI. As a result, ESG is already deeply embedded in corporate value, and when scandals occur, half of a company’s DCF goes immediately pear shaped. Who wants to get that wrong? Here is where existing ESG data is useful and in fact mission critical.
That said, ESG data has a history of being oversold as something useful beyond this use case listed in 2. above. While this risk oriented use case makes ESG data mission critical, the data providers had a history of never being profitable in their early years of existence, and so there was a history of overpromising and under delivering, arguably a form of greenwashing itself. You want to deal with climate change? Come, buy our data and we will help you. Yet, those same data providers to this day don’t really track whether and how companies are transitioning. Even the Transition Pathway Initiative itself doesn’t appear to offer a transition pathway category, at least for the Oil & Gas sector. And so what percentage of the field more generally is greenwashing, we have to ask, sadly.
ESG data is also incomplete and inconsistent at best, and standards have been lacking. There is almost no useful ESG information in Asia, that’s half the world’s economy right there, let alone on private and state owned companies and startups, where most of the innovation is happening in the exciting realm of (PS cool new website here!) Climate Tech VC. (Do Red State attorneys general really not want to make money in this area? Hello again fiduciary duty considerations). Existing ESG data really is still largely limited to large cap, developed world public companies. Efforts are underway to standardize the wild west of ESG information (yes, the MIT effort around Aggregate Confusion is a good place to start on the data challenges at hand). Ongoing initiatives such as ISSB, taking from the work of SASB can help, but these sustainability standards need to make sure they are clear on what they are and are not. There is a risk of companies being sustainable by some measures, but their efforts being insufficient for solving climate change, for one important example.
Same is true of the TCFD, or the Task Force on Climate-Related Financial Disclosure. Fine, companies and investors can and should report on their physical and transition risk from climate change, but again there is a serious risk of organizations reporting they are fine, and this not resulting in necessary action for solving climate change. And so, whether it is corporate sustainability standards or efforts such as TCFD, we always need to mindful of how the overall global financial system and economy needs to look, to develop roadmaps by country for what needs to happen from a low carbon transition perspective, and finance those transitions, and annually measure whether we are making the global progress we require. There is risk that needs to be avoided of more reporting for its sake.
That said, we more than welcome the SEC’s climate disclosure rule, in the middle of its initial comment period as we speak, and similar moves to encourage more corporate and investor reporting around the world, swiss cheese in nature as these things might seem at times. The EU’s SFDR is another example of a work in progress which we welcome, for all of the ongoing challenges involved with the EU taxonomy . Reporting requirements have made corporations sit up and take notice. Everyone can see that climate change effects will only get worse, and transparency forces companies to think harder about what they are doing and where, especially given reputation risk as a major component of intangible value as in 2. above (hence this needs to be fully tracked and considered in Asia going forward). More disclosure encourages action, we welcome it and the world will only get more transparent, making ESG considerations even more essential.
And the same can be true of Net Zero as a concept. Sometimes it makes you scratch your head, and Net Zero commitments can be an excuse for inaction and delay if we aren’t being careful, so watch for calls for specific action plans, such as the recent announcement in this regard by GFANZ on what is a legitimate plan and requirements to disclose these plans. This work will only continue to evolve, and is more useful than sometimes meets the eye as a benchmark for investors and countries such as China and India to work backwards from and encourage necessary and important transformation to begin to actually occur. Conversations on what is truly necessary by each actor will only accelerate one can be fairly certain, regardless of the EU’s struggle to adjust to the Ukraine invasion and its prior reliance on Russian fossil fuel.
Also, when it comes to ESG issues, sometimes investing can help, but not always (see last week’s Substack piece which was on this subject for more on why we need to stop talking about ESG Investing as if it is a single thing, ESG is not a single thing, neither is ESG Investing - there are 7 Tribes of Sustainable Investing all of which need separate consideration).
Accusations of greenwashing aren’t a bad thing, they are a good thing. If we seek to solve for the SDGs (and we should and must), then we need to measure seasonally for how we are doing at solving these goals, and develop specific case studies of what is actually working, that can be scaled for ESG, sustainability and impact purpose. This is what we teach in our classes. It is also what we have brought to our events, at Yale in 2017, and in China in 2019. Indeed, if investment and corporate strategies aren’t improving outcomes, then we need to think twice.
Further to these 7 Tribes, ESG Integration, one of these specific and distinct categories of investment action, had been the preferred method of the largest financial institutions, buying multiple data sources and coming up with their own algorithms, but how useful is this method really? Let’s be honest, negative screening unless scaled doesn’t make companies of concern magically disappear. Positive screening is fine, we believe this creates a positive dynamic that can help investors and the system achieve a dual sustainability/financial paradigm as we have long encouraged in our seven books on the subject. Impact and thematic investing arguably are the most important direct forms of investing across asset class to help scale take up of renewable energy, to maximize innovation and enjoy in its success and to help provide services to those less well off. There are questions about ESG Integration and shareholder engagement for that matter on whether these categories of effort can truly be transformational, but we remain convinced that the seventh tribe, minimum standards, such as we suggested to NYS Common back in 2018-19, remain the best way to bring engagement and divestment advocates together, across all sectors, to make engagement successful by insisting on a result.
In conclusion, ESG has become politicized, arguably by both sides if we are being honest. But at the end of the day, there are societal outcomes which need to be achieved, and there were always going to be winners and losers, and those who think they are going to lose should always have been expected to push back.
The sustainability paradigm is upon us, and it is a global paradigm, much as are the many challenges we face cutting across climate change and other categories of pollution, and so much more as we consider ESG issues fully.
At the end of the day, there are five areas of effort required: a) corporations need to do all they can, and they are starting to, and this can be monitored and measured going forward in a word that will only become more transparent, partially through the efforts of standard setters and data providers as above, but we also need to be cognizant that quantitative standards and data will never tell the full story, hence the real action on sustainable investing has been and will be active not passive (that’s good news for an industry long pressured on fees), b) investors need to be all in, and we have methods for detecting standards on impactful strategy (such as the work we have done over time at Real Impact Tracker, and which methodology we open sourced), c) we also need policy to encourage the right choices by corporations, investors and people, however policy requires, d) people to want the policy to be in place, otherwise they will vote out politicians as they did years ago in Australia when it came to a carbon tax, so we need to develop policies that people can accept, and most of all, build an accepted global consensus for action, or policy will be circumvented (all too often this essential component of global buy in is overlooked, including by climate philanthropists), and e) we need to maximize on innovation.
This is how we can measure progress and ensure success, by pushing on all of these five areas at once, building a global consensus to act, and roadmaps for implementation.
Will ESG survive? What does that even mean?