The term ESG — a measure of how businesses perform on Environmental, Social, and Governance factors — was coined in the mid-2000s. But as a movement, ESG repackages ideas such as Impact Investing and Socially Responsible Investing that have been around for a longer time.
The ESG movement received a fresh impetus during the COVID-19 crisis, which ravaged the world in 2020. ESG investing saw a sharp spike, with ESG-leaning equity funds receiving inflows of $168.74 bln in 2020, compared with $63.34 bln in 2019, according to the latest preliminary data from global fund flows tracker EPFR. Terms that have been commonly used to describe the ESG journey through 2020 include watershed year, inflection point, and tipping point.
So, what is it about the pandemic that made the business world wake up to ESG in such a big way?
At the peak of the pandemic last year, when a number of countries had to impose large-scale shutdowns to prevent the spread of the COVID virus, only those businesses which could handle the bulk of their operations remotely via the internet managed to sustain.
Firms that were dependent upon global supply chains and/or needed their employees to be on-premises to handle operations found it hard to live through the crisis. Many firms could not support their employees — firing some and delaying paycheques for others.
It became apparent that the traditional way of doing business was not going to work out going forward. The business and investor community had to factor in measures that make companies resilient in a time of crisis. Moreover, it dawned upon the world at large that the pandemic and disasters brought about by climate change were the direct result of human interference with the natural order.
These realizations culminated in ESG becoming a hot topic in 2020.
The search for common ESG reporting metrics
What has been missing in the ESG ballgame is a common set of metrics based on which to measure companies’ performance on sustainability factors. Various global sustainability standard setters have their own set of metrics for companies to use, which results in companies using a patchwork of the different metrics.
This has raised the problem of comparability. There is no way to compare, for instance, how two companies have performed on ESG factors when each has used a different set of metrics to report their information.
Realizing this problem, two separate groups of standard-setters and global bodies have come together in the recent past to work towards creating a common set of sustainability standards.
In September 2020, a group of five standard-setters — the Carbon Disclosure Project (CDP), the Climate Disclosure Standards Board (CDSB), the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Sustainability Accounting Standards Board (SASB) — came up with a statement of intent to align their various standards to prevent ‘conflicting sets of standards’ from impeding progress on ESG reporting.
In the same month, the World Economic Forum released a set of ESG metrics developed by the Big Four accounting firms – Deloitte, KPMG, PricewaterhouseCoopers, and Ernst & Young.
The efforts by these two groups run parallel to several other initiatives on sustainability reporting.
The Sustainability Accounting Standards Board, which is one of the signatories to the statement of intent, is developing an XBRL taxonomy for the 77 sustainability standards that the body has come up with. XBRL or Extensible Business Reporting Language is an open data standard that is increasingly being mandated by market regulators worldwide for business reporting.
One possible solution to the ESG reporting issue that has found wide acceptance is the setting up of a Sustainability Standards Board by the IFRS Foundation. Among the proponents of this idea are the European Securities Markets Association (ESMA), Accountancy Europe, and the five standard-setters whose statement of intent is mentioned above.
Here’s the ESMA’s response to the IFRS Foundation’s consultation on setting up the SSB: “ESMA welcomes the initiative of the IFRS Foundation to consider establishing a Sustainability Standards Board (SSB) which could succeed in consolidating the best practices arising from the existing frameworks and standards under the responsibility of a credible full-time board of independent technical experts…”
ESMA has also stressed that the SSB if established, should work towards digitizing sustainability reporting based on an XBRL taxonomy so that there is integration between financial and non-financial disclosures.
Problems with the ESG movement
Definition of ESG
One of the first problems with the ESG movement is that of definition. Is ESG investing synonymous with values-based investing?
Not really if one goes by this statement from a C-level executive with a prominent exchange-traded funds provider. “Sustainable investing was historically a values-based exercise — it has evolved into an investment risk and performance-based decision…”
Such an ‘evolution’ explains the presence of oil company stocks in the S&P 500 ESG Index. Even the ETF provider mentioned above maintains exposure to ‘sustainable alternatives’ after screening out ‘companies with specific levels of involvement in certain industries such as fossil fuels, tobacco, small arms, and controversial weapons’.
These are facts that investors who equate ESG investing with doing something good for the environment and society find disconcerting. This class of investors would choose to avoid certain sectors of an economy or ‘sin stocks’ to remain true to their values. For them, ESG is a continuation of the concept of Socially Responsible Investing.
To deal with the confusion arising from the separate doctrines, this MarketWatch article suggests that before putting money into an ESG fund, investors must review its investment criteria, check its largest holdings, and weigh what factors (or values) are important to them at a personal level.
How ESG is being marketed
Not everyone has jumped on the ESG bandwagon. The movement has its skeptics — and prominent ones to boot — such as the ‘Dean of Valuation’, Professor Aswath Damodaran.
Damodaran’s main contention is that ESG is being marketed as something that would not only benefit society but also bring value to companies and investors.
The latter part does not add up, according to Damodaran, who says, ‘Doing good can add value at some companies and may destroy value at others.’
Another prominent ESG skeptic is the economist Bradford Cornell of UCLA Anderson School of Management. Cornell recently wrote in an opinion piece in The Financial Times: “[T]here are costs to being good in many situations and denying these costs, or arguing that the benefits always exceed the costs, is dishonest…”
The present momentum around ESG is not based on facts, data, or common sense and qualifies more as hype, according to Damodaran, who believes the move would only end up enriching consultants, bankers, and investment managers.
As things stand, there seems to be no agreement within the business and investor communities as to what the ESG movement is setting out to do. And in a world fresh out of the worst crisis in living memory, it is only justified that decibel levels would be high in any discussion on sustainability. But what is vital is to keep the dialogue going.
If all stakeholders on ESG come to a consensus on what the sustainability movement must achieve, then the world would have learned the right lessons from the COVID-19 pandemic.
This article was first published on Anuradha RK’s LinkedIn page.