This article examines the issues that the term ESG has been facing, going on to examine the possible routes that the reporting tool could take in order to become a more useful tool.
As the climate crisis intensifies, the well-known acronym ‘ESG’ has reached a crossroads of sorts in the direction it will take. Coined in the mid-2000s, for nearly two decades now the acronym has materialised frequently in both investing and reporting. But the truth is, the term has come under increasing scrutiny from investors and consumers alike, who openly question its efficacy and focus. Whilst an entire revamp of the current metric is not necessarily the only answer, the term ESG needs to stop being interpreted as purely an environmental insight into a company and instead be understood for its entire meaning. In this article, I will therefore touch upon issues emerging from the breadth of ESG and suggest what can be done to combat the increasing alienation of an otherwise very useful and necessary term.
ESG has been tainted by loopholes and an inability to compare across industries
Many companies are no stranger to manipulating statistics to alleviate their performance metrics, whether it be around recognising revenue, forecasting profits, or reporting on ESG progress. Where there is no official, standardised reporting process for ESG, it is often viewed as a somewhat reporting ‘free for all’, which ultimately reduces its credibility. With companies tending to report on what they deem to be the most flattering measures for their company and ignoring those which do not shed such a positive light on operations, the utility of the ‘ESG’ term is increasingly questioned. There is also the matter of ESG reporting being used comparatively across industries. This June, for example, S&P Global caused controversy when giving Tesla, famous for revolutionising the electric vehicle (EV) transition, a lower ESG score than Philip Morris International, a tobacco company. The determining factor in this comparison came from both the high governance and social scores boasted by tobacco companies, as well as Tesla’s lack of low carbon strategy, employee discrimination, and allegations of poor working conditions in its factories. This outcome in the comparison of a seemingly ‘green’ company against a ‘sin’ one provoked surprised reactions across the world and is just the tip of the iceberg when it comes to a need to change the way in which ESG is calculated and perceived.
Why is this?
The bottom line is that the term ESG is wholly misunderstood by the market as a term which summarises a company’s ‘greenness’. In fact, the ‘E’ in ESG is no more important than the ‘S’ and ‘G’, and therefore the fact that Tesla scored lowly should not come as a surprise, and in fact serve as an educational tool to investors who do not solely want to climate-proof their investments, but also de-risk in other areas. The resultant ESG scorings taken at face value instead discredited the term, contributing to the “anti-woke” agenda, with Elon Musk tweeting that “ESG is a scam”. It was not difficult to read articles, or overhear conversations ridiculing ESG as a reporting metric after Tesla was removed from the S&P 500 ESG index, whilst six oil companies managed to remain.
What can be done?
This concerning trend suggests that if reporting is to become more transparent for both consumers and investors, the way in which company activity is understood must change. There are seemingly two ways in which this can be done; a better education surrounding ESG, or a revamp in the way that companies’ sustainability metrics are reported. The former would be hard to achieve given the fact that the term has been ingrained in the minds of investors since the 2000s and has had a recent fall from glory. It would also require those using the metric to have to dig deeply into companies to uncover exactly what is driving, and being masked by, the score. However, if achieved properly, would mean companies as a whole become understood properly, and therefore generate wiser investment and purchasing decisions across the board. The latter would be potentially easier to execute, but would require a rewriting of what many investors and consumers have become accustomed to.
Whilst there are many forms which this revamp could take, my suggestion would be to simply split out the ‘E’, ‘S’, and ‘G’ into three separate reporting categories and lists in order to make comparison less complicated and more transparent. This, of course, comes with its downsides, and risks the ‘S’ and ‘G’ components being overlooked by pureplay climate impact investors, but it does resolve the over-consideration of climate matters. To be effective, both measures would need to be accompanied by an effort to standardise reporting, an initiative which many governing bodies and organisations are working towards. Will this be done at a rate quick enough to save ESG? Ironically, only time will tell.
On balance…
Despite what Elon Musk may say, I don’t think it’s all doom and gloom for ESG. The output of the metric is undoubtedly very important; it gives both consumers and investors an insight into how morally a company operates across multiple different factors. The issue lies where ESG is falsely interpreted as a “green” reporting method only, hence the shock when Tesla was taken off the rankings, or when the often-manipulated measures are taken at face-value without further investigation. Ideally, with an improved education and standardisation surrounding the term, or a complete overhaul of how companies are compared and assessed, reporting and decision-making can become more transparent, and ultimately feed into improved business sustainability across the board.
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