ESG IS DEAD... Long live sustainability!

By Luke Heilbuth, CEO BWD Strategic

ESG is dead, buried by its own hubris, the American culture wars, and the cooling interest of fund managers herding sheep-like towards the next tradable fad. But even true believers should remain dry-eyed at its passing.

This is a contrarian view. So why do I hold it with conviction? This article explains why ESG has become toxic, and how its underlying principles should be reconceived to support long-term business success. Spoiler: The solution – reframing ESG as sustainability – is hiding in plain sight.

WHY THE ESG BUBBLE BURST

Look around. I bet you still see ESG everywhere. I’ll admit to using the phrase until well into 2023. So why herald its end? Because ESG has lost its relevance, much like corporate social responsibility in years past. Let’s unpack why.

1. The Republican Party weaponised the term

In the past 18 months, Republicans have found a new source of red meat to energise the base: ESG. Trump, De Santis and Ramaswamy have made hay on claims that ESG equals woke capitalism, at odds with a business’s fiduciary duty to maximise returns for shareholders. The pressure is working. Once a noisy advocate, BlackRock CEO Larry Fink now says he won’t use the ‘weaponised’ term.

The counter-offensive has been funded in part by fossil fuel interests. After years on the defensive, they’ve seized the political moment to strike back against environmental activists. Take Exxon, which recently filed a lawsuit to prevent a climate proposal from even reaching a shareholder vote; a move that would have been PR suicide at the peak of the ESG bubble in 2021.

In January 2024, Republican lawmakers in New Hampshire introduced a bill that would make it a felony to consider ESG factors in an investment made on behalf of the state, punishable by up to 20 years in prison.

This all might sound irrelevant to readers outside the US. But that view misunderstands the omnipresence of American soft power. Like it or not, American norms infiltrate every aspect of global culture. If Wall Street titans like BlackRock excise ESG from the corporate lexicon, many overseas equivalents will follow.

2. Fund managers fell out of love

Investors have always considered ESG factors in their capital allocation decisions. But in recent years, a critical mass has come to realise that some non-financial risks are systemic in nature, capable of breaking the most basic assumptions of an investment thesis.

The GFC took to the global economy to the brink, for example, by exposing the inadequacy of the financial sector’s approach to governance. Many Wall Street firms are only extant today because of the largesse of the American taxpayer.

ESG investment reached its peak at the end of the COVID pandemic, as fossil fuel prices languished and global capital turned its attention to the enormous financial opportunities of the transition. By 2022, US$100 trillion sat in ESG funds .

The bubble has deflated since, driven by tighter scrutiny of fund greenwashing , political opportunism, and the revival of fossil fuel prices post an extended war in the Ukraine. Just six funds citing ESG considerations launched in the second half of 2023, compared to 55 in the first six months of the year.

Some of the ESG ‘experts’ inhabiting the sleazier end of funds management have turned to spruiking generative AI. More cerebral investors, though, have argued that ESG has always been intellectually compromised. While ESG ratings agencies play a role in promoting responsible business practices, ratings tend to make little intuitive sense. For example, tobacco giant Philip Morris International scored 85 out of 100 in the 2023 S&P Global Corporate Sustainability Assessment (CSA). Tesla scored 36 .

Elon Musk is rightly criticised for his dumpster fire approach to corporate governance. But it’s hard to take seriously a ratings framework that lionises a company which intentionally kills people for profit, while recording as a laggard the business which single-handedly ushered in the electrification of transport.

3. ESG got high on its own supply

This critique may not endear me to the vested interests that inhabit the ESG universe. But ESG is having its reckoning in part because it moved away from its core value proposition – creating value in a responsible and ethical way. Republicans might have politicised the issue, but they could only do so because of the bad or misplaced faith of a range of ESG advocates.

Guilty parties include:

·????? ESG ratings agencies tying companies in green tape

·????? Consultants greenwashing for fossil fuel interests

·????? Corporate sustainability professionals peddling ‘win-win’ claims

·????? Management adopting social causes to virtue signal

Let’s briefly review each.

ESG ratings agencies

Many of these agencies charge companies for the dubious privilege of being rated at all, ensnaring sustainability and finance teams for months in costly and demoralising green tape through boring questionnaires.

This is an emperor’s new clothes scenario. Corporates know that taking three different analytical pillars (E, S and G) and combining them into a single score provides little useful information about their company’s ethics or investment quality. But they pay for the hustle anyway, not wanting to risk being excluded from an ESG investor’s screening process and the financial loss that could result.

The irony is palpable; in seeking to measure ethical behaviour, the process itself is anything but. In fact, for-profit ESG ratings agencies create rent-seeking behaviour twice over. First, by charging companies to create their product for them (ESG scores). And second, by supplying those scores to ESG investors, who charge unjustifiably higher fees to clients for investing in an ‘ethical’ fund. We are left with a circular economy of profit under the guise of principle; a marketplace built on the appearance of virtue, rather than its practice.?

Consultants

Many consultants, meanwhile, swear undying support for the transition while taking the dollars of oil and gas companies actively seeking to slow it. Admittedly, this is a grey area. Improving the ESG approach of a company in a hard-to-abate sector can provide some of the most impactful consulting work available.?

But in my view, the prospective client must have an evidence-based transition plan. Without one, consultancies are complicit in greenwashing and cannot credibly claim they are committed to a better future. Our consultancy, BWD , does not work with companies which do not take a scientific approach to the transition, despite the financial cost.

Corporate sustainability professionals

Another ESG fudge is the tendency of corporate sustainability professionals to claim that social and environmental objectives align with opportunities for profit. In reality, ESG-focused business decisions often increase costs and reduce efficiencies, even as they enhance organisational resilience . An example is investing in a diversified, slavery-free supply chain, robust enough to withstand single points of failure. This is a good business decision, but the costs are real.

Sustainability practitioners lose credibility when they downplay the costs and trade-offs inherent in ESG. You might win a battle, but you’ll ultimately lose the war. A decision-maker, often the CFO, who says yes the first time an overly optimistic ESG claim is pitched will often say no second time around.?

Virtue signalling management

In recent years, some CEOs have been outspoken on social issues that have little to do with their business. I’ve changed my mind on the wisdom of this stance over the past year based on the public mood, which sees big corporates as generally elitist and out-of-touch.?

Whether a business leader engages in social advocacy should be decided on a case-by-case basis. One threshold question to ask is whether the cause under consideration has a direct link to the business’s industry or offering.

That said, it is almost always a mistake to virtue signal a cause célèbre to appease the demands of a vocal minority when doing so will alienate a much larger base of employees and customers.

'REAL' SUSTAINABILITY IS MORE IMPORTANT THAN EVER

The critique above might imply that I’m wavering on the role that sustainability can play in accruing long-term business success. Nothing could be further from the truth.

The swing towards sustainable business has happened at speed, and with all that money from the transition on the line, some whiffy practices have emerged. Some kind of recalibration was inevitable, even healthy. Calling time on ESG is not a dismissal of sustainability, but a recognition of its enduring importance.

Indeed, the intellectual underpinnings of the ESG movement are more relevant than ever. Any moderately capable decision-maker recognises the paradox of making money. Considerations outside the balance sheet – social norms, political trends, emerging technologies, demographic changes, natural resources, climate change – will always be critical to sustaining shareholder returns over time.

At the risk of torturing a metaphor, my children love Disney movies, especially Moana. If you’ve seen it, you’ll remember Te Fiti, the goddess who provides her heart to allow the world to flourish in perpetuity. When the trickster Maui removes it, the islands and seas are plunged into darkness. Sustainability is similarly the lifeblood of a business, the secret to its flourishing over a long span of time.

THE GOAL OF SUSTAINABILITY

The goal of sustainability is to build long-term value and resilience for an organisation.

These two ideas – value and resilience – are mutually reinforcing. Valuable businesses are more resilient, because of the financial buffer at their disposal in navigating challenging times. Resilient businesses are more valuable, because they’re capable of evolving in the face of the inevitable shocks and tipping points which eliminate less hardy competitors.

There are multiple benefits for a business that frames sustainability in this way:

·????? A business’s sustainability strategy is indistinguishable from its enterprise strategy because the common objective is to build long-term value and resilience.?

·????? Sustainability must necessarily become part of everyone’s job because every employee must contribute to long-term business value.

·????? Sustainability can’t be easily politicised, because all rational people agree that value creation and resilience are goals worth pursuing.

?·????? Sustainability does not pretend win-win outcomes are always possible. Financial costs are real and ethical trade-offs common.

·????? Focusing on ‘value’ in the general sense respects that a business may choose to create non-financial value as an end in itself, like supporting sustainable development outcomes through the SDGs .

·????? Focusing on ‘long-term’ value protects the organisation from implementing fads and moral panics which do not enjoy widespread societal support.

·????? Focusing on resilience accepts the reality that the future is unknown, and that to succeed over time, businesses must prepare for constant change.

·????? Sustainability (unlike ESG) incorporates systems thinking ; the wisdom to understand and accept that a business’s success is ultimately contingent on the flourishing of the society and the planet that surrounds it.

In conclusion, any shift from ESG to a broader and more integrated concept of sustainability is not a retreat but an advancement in our understanding of what makes a company succeed or fail over time. As champions of our discipline, we must embrace the notion that sustainability is an investment in quality; the ultimate decision-making hack for leaders seeking to ensure their business prospers through the vicissitudes of time.