‘ESG’ is an acronym that stands for environment, social and governance. It is a global attempt to consider businesses from these three perspectives and rate them in terms of how their activities impact on these three areas. ESG is gaining momentum as fund managers, factoring companies and banks look to invest ethically. ESG is an alternative bottom line to profit.
One fruitful way of gaining a better understanding of what ESG does is to list the areas of concern it most commonly addresses:
Environment – fighting climate change by reducing carbon emissions and greenhouse gases; husbanding land and water resources so as to promote the health of ecosystems; reducing pollution and waste, and innovating eco-friendly design.
Social – Improving relations with the workforce through better pay, better conditions, better training and promoting diversity. Improving relations with customers by producing quality goods and services that are safe. And improving relations with wider society by engaging in community projects and charity drives.
Governance – Involves securing shareholder rights, creating a board with qualified, diverse and independent members, and rooting out bribery and fraud.
The Focus on Climate Change
We are up to COP27. Greta Thunberg boycotted the event, dismissing it as ‘green washing’. Every year sees terrible floods, droughts and wild fires. The increased frequency of such disasters is unequivocal evidence to the general public that the climate is getting more inhospitable and dangerous. Warnings of inevitable rises in global temperatures causing coastal regions and islands to disappear, food production to plummet and mass people displacement have led to increased media headlines and the formation of groups dedicated to fighting fossil fuel companies and their enablers.
Political parties of every persuasion are incorporating ‘green’ policies into their manifestos as they see this as a pre-requisite to winning elections. Climate deniers are increasingly being exposed as shady lobbyists for corporate interests wanting to maintain the current status quo in farming, natural resource management and energy generation.
The Intergovernmental Panel on Climate Change (IPCC) has been monitoring average global temperatures. They now conclude man-made greenhouse emissions at their current rate will cause the Earth to warm well beyond 1.5 C above pre-industrial levels. The disastrous consequences of this warming will by 2030 be evident – irreversible damage to the planet. In short, we are at the precipice. Unless we turn back, we fall to our deaths.
2030 is a date that is worryingly close. It is in most people’s lifetimes. While activists grasp the need for immediate action, business has been slow to respond. However, market forces have started to respond to the imminent crisis: there are a few academic papers detailing how businesses with high carbon emission outputs are seeing market evaluations reflecting their negative impact. Insurance premiums for economic activity that produces greenhouse emissions have also risen. In response, ‘decarbonising portfolios’ have been offered to investors. Unfortunately, surveys of large institutional investors have shown that their main concern is maintaining the monetary value of assets rather than securing a healthy planet for their children and grandchildren.
It is in this dire context that ESG operates. US businesses reporting of ESG metrics is voluntary. A regulator is needed to enforce ESG reporting in a standardised manner so that accurate statistical analysis can be mandated and published. The problem is that some business activity is clearly currently impossible without burning fossil fuels (such as air travel) and these sectors are wary about a regulatory framework that will financially penalise them.
Similarly, investor stewardship codes that instruct institutional investors on their responsibility to address ESG concerns are not legally binding. The UK Stewardship Code brought in by the UK Financial Reporting Council in 2010 (https://www.frc.org.uk/investors/uk-stewardship-code) remains voluntary. In 2014 the Financial Reporting Council concluded that “too many signatories fail to follow through on their commitment to the code” (Financial Reporting Council, Developments in Corporate Governance and Stewardship 2014).
In America the entrenched culture war between liberals and conservatives has stymied positive political action. As presidents change so does the fiduciary duties of pension fund managers. Obama sought to include ESG factors; and predictably, Trump overturned this initiative. The SEC unhelpfully declared that investment advisers cannot put any interests (including ESG factors) above their clients’ interests.
The European Union has been less illogical. In 2018 the European Council published Action Plan: Financing Sustainable Growth. In it they set out a vision of channelling private capital to sustainable projects that will help to achieve the targets set out in The Paris Agreement that they signed up to. This has seen a drive in Europe to develop sustainability benchmarks. Why public funds cannot also finance sustainable growth is a moot point for European greens.
In the Far East the Chinese Communist Party has issued “Guidelines for Establishing the Green Financial System” in 2016. Japan has avoided legislating on the issue, and instead seeks to promote the voluntary adoption of ESG factors and disclosure of relevant metrics.
In Summary
The main thrust of ESG in terms of fighting the causes of climate change has been setting up regulatory systems to encourage the adoption of green technologies and the abandonment of fossil fuel burning and other activities that increase carbon and greenhouse emissions. While governments around the world acknowledge the need for action on climate change, neo-liberal thinking has made regulatory systems seeking to combat climate change toothless. Money still speaks louder than floods in Pakistan, famine in Africa and wild fires in Australia.
An enduring problem with ESG reporting is the prevalent belief among investors and many of the general public that fixing the climate crisis will be expensive. They don’t see any monetary benefits to ESG measures. While the Earth spins on and the money keeps coming in there is always tomorrow to deal with the climate crisis.
