Time to reflect: putting ESG criticism in context

ESG has faced criticism from nearly every corner of financial markets lately. In this article, Caroline Haas, Tonia Plakhotniuk, and Fjordi Mulla help put that criticism into context.

That’s partly because different, complex topics are being unhelpfully wrapped into popular buzzwords. At the same time, the role of corporate sustainability is being muddled with larger-scale geopolitical issues. All of this is diverting focus away from some of the basic principles of ESG: sound corporate governance and accountability.

Sustainability is not a new concept. It has been quietly pursued by corporations over many decades, benefitting those that truly support the essence of it. In practice, it means creating the conditions under which people and nature can exist in productive harmony. In financial markets and the business world, this translates into actively preventing the depletion of natural, physical, and social resources. But how does ESG fit into this? A little historical context is needed.

The birth of a movement

The term ESG was first used in a UN-sponsored 2004 report entitled “Who Cares Wins” as part of a move to better integrate environmental, social and governance issues into capital markets and, in doing so, make them more resilient.

Sustainable development was, and still is, generally accepted as "development that meets the needs of the present without compromising the ability of future generations to meet their own needs". This definition was coined and popularised earlier, in the 1992 report “Our Common Future”, presented at a UN summit that marked the first international attempt to set out an action plan for a more sustainable pattern of development.

A story of sustainability

"Sustainability” and “sustainable development” both involve preserving resources for the long term and sustaining present systems for the future. The development is the key difference between the two.

Sustainable development contrasts with development that focuses on socioeconomic gain, often at the expense of the environment, in industries such as mining and fishing. The explicit reference to “sustainable” in  in the 1992 report alluded to concepts such as limits to growth, soft energy paths and eco-development.

Kofi Annan, UN Secretary General behind the creation of the United Nations Global Compact, a voluntary initiative based on commitments to implement universal sustainability principles, believed that “the goals of the UN and those of business can be mutually supportive.”

The UN Global Compact was the first initiative that corporations worldwide recognised when considering issues of human rights, labour, the environment, and anti-corruption – the four segments of the Compact’s 10 principles. Today, it is the largest corporate sustainability initiative in the world.

As the private sector became more heavily involved in sustainable development, ESG gained in prominence. Slowly, ESG became the way to approach sustainability by default.

The Who Cares Wins report’s endorsing institutions explicitly stated that sustainability and ESG are not the same thing. But what’s important is that early ESG reports agreed that, for stable and predictable markets in a globalised, competitive world, participants should focus on the quality of management of ESG issues. They believed that companies that contribute to sustainable development should outperform those that do not.

“Successful investment depends on a vibrant economy, which depends on a healthy civil society, which is ultimately dependent on a sustainable planet.”

-          Who Cares Wins

Climate risk increases and inequalities grow

In the years since, ESG has become a widespread term. Profoundly complex issues are now being assessed through an ESG lens: a good example is whether investing in the defence industry can be seen as in support of ESG given what’s currently going on in the world.

At the same time, environmental problems are worsening, with global greenhouse gas emissions continuing to rise and natural ecosystems suffering permanent damage. Meanwhile, social inequality is widening. No wonder, then, that ESG is attracting criticism amid allegations of greenwashing.

Today, ESG integration is being actively applied to $35.3 trillion of assets under management, but can asset owners rely on what their asset managers are telling them? Regulators have been investigating sustainability-related claims by asset managers including GSAMDWS and BNY Mellon. Meanwhile, the ongoing energy crisis has led to excellent returns for oil & gas companies and the non-ESG strategies that invest in them so far this year. 

Back to basics

Perhaps it’s time to get back to the basics of what corporate sustainability is all about. Ultimately, if an organisation manages its environmental impact, treats customers, employees and communities well, and has robust corporate governance, it is probably a sustainable business. Some claim such issues are “soft” factors. However, they have a direct impact on companies’ financial materiality and creditworthiness. Firms with good practices should be able to balance the short-term financial performance required by the market with long-term vision and purposeful decision-making.

Misunderstandings have arisen as a result of ESG becoming a catch-all term. But it’s important to remember that ESG is intended to help with the assessment of the financial and non-financial materiality of business decisions, including the relevance of corporate purpose, strategy, and management to facilitate environmentally and socially responsible investing and enterprise. 

From an asset management perspective, investment vehicles must be transparent about whether and what ESG strategies are incorporated into their processes, with appropriate supervision to prevent misrepresentation. But even in the EU, which has been driving sustainable finance policies for several years, regulation has barely entered the active implementation phase. Progress and improvements in this regard can be expected in the coming years.

Disclosure moves up the agenda

Enhanced sustainability disclosure requirements are approaching, with the EU set to oblige all large and listed companies to include sustainability-related information in their annual reports. Meanwhile, the UK’s Sustainability Disclosure Requirements regime will expand disclosure rules beyond climate considerations. At the international level, the International Sustainability Standards Board wants to standardise definitions and sustainability reporting on a global scale.

This all means that there will soon be greater clarity about sustainability risks and factors and greenwashing will become more difficult. Greater accountability will eventually benefit markets, the environment and society. But it’s important to remember that sustainability has already been a driving force for good for business and for the world for many years, and this will continue.

Get in touch

To learn more about the impact of ESG and sustainability risks on your business, get in touch with your NatWest Representative or contact us here.

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