Today, issues including social justice, environmental consequences of businesses are more relevant than ever before and so a new ideology was introduced to help tackle this. The framework ESG was first introduced in 2005, in the United Nations Environment Programme Initiative. ESG which stands for environmental, social and governance aims to capture all the non-financial risks and opportunities within a company, country and an individual’s actions. This framework remains important today as rising issues such as climate change continues to worsen social and environmental consequences globally. By incorporating ESG, businesses are able to act responsibly and assess the risks and opportunities. ESG started to emerge as a proactive movement in the late 2010s and has now evolved into a comprehensive framework addressing issues in the environmental and social sectors. This was due to the increasing awareness of socially responsible investing and the severe environmental impacts of businesses.
One of the issues with ESG is there is no standard framework, which can result in complications when applying the framework. The 2 most common ways to use ESG are: the Global Reporting Initiative (GRI) and the Sustainable Accounting Standards Board’s standards (SASB). However, there still needs to be a standardised version.
One main problem with ESG is the lack of transparency of the reporting process. Transparency is an important element, businesses have to consider, in order to become sustainable. ESG rating agencies do not offer complete and public information about the criteria and the assessment processes developed to evaluate sustainability performance. For example, Amazon claims to make greater transparency possible but is one of the least transparent companies in the world. Several companies publicly showcase their involvement with ESG to cover poor business performance. There’s a term called greenwashing which is the process of conveying a false impression about how a business is more environmentally responsible. More businesses are trying to greenwash and use the fact that they are integrating ESG but there have been no actual improvements in the sustainability of their businesses. Data transparency is the way forward for investors to ensure any ESG information is accurate and not misleading. Therefore, this will allow making informed decisions easier when assessing ESG reports.
In addition, a study has shown that ESG funds have been performing poorly financially. ESG funds are bonds where ESG factors have been integrated into the investment process. Investors are applying this framework as part of their analysis process to identify material risks and growth opportunities. However, ESG funds don’t seem to deliver ESG performance well. Researchers have discovered that some companies using the ESG framework did not improve compliance with their labour and environmental regulations. One reason for this is because ESG funds are redundant in competitive labour markets because setting ESG targets can distort decision-making. Moreover, most ESG funds invest in securities that trade in secondary markets. So even if protecting the environment was a principal objective in ESG investing, measuring this impact would be unfeasible because almost all ESG funds invest in securities trading in secondary markets.
Another issue associated with ESG is commensurability. ESG reports may be used and measured in different ways. If assessments are not consistent then ESG reports and data cannot be compared. Most ESG reports provide environmental, social and governance rates but do not provide an overall score of the businesses’ sustainability performance. Again, this means that a company’s sustainability performance cannot be compared to others. This is why there is a need to come up with a standard ESG framework. The delay in coming up with a standardised ESG could be because of evolving ESG regulations. For example, the EU is currently leading big initiatives to achieve the goal set out by the Paris Climate Agreement 2015.
In terms of the social aspect of ESG, the framework includes measuring the social impact of a business. These can include: human rights, product quality issues, health and safety, digital rights and socio-economic inequality as well as diversity and inclusion. However, measuring social impact is subjective and can differ in different situations. For example, an investment in job creation might mean the city will measure overall reduction in unemployment rates whereas community activists might measure changes in average wages as a measure of living standards. This makes it harder to standardize and compare ESG data between businesses. And so, we need to come up with quantifiable measures of social impact.
Overall, this article has highlighted the fact that there is no single ESG framework that will adequately address all investor needs. As explained above, there needs to more efforts in creating a framework that is more transparent and commensurable. A new model for a social impact assessment is required, that includes coverage across all ESG issues. Although, I have highlighted the cons of the ESG framework, there has been evidence that ESG has improved the sustainability practices of several businesses such as ARCADIS, Mott MacDonald and Microsoft. Businesses as well as individuals need to embed sustainability into everything we do but there needs to be more support in how companies can implement ESG in an effective manner.
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