ESG: Is it enough?

ESG. Investors will demand it. Consumers will prefer it. Regulators will require it. But is it enough?

In the rush to jump on the ESG bandwagon, the true meaning and purpose of ESG can become diluted and its limitations overlooked. What does ESG really mean? Why does it matter? What are its limits?

Defining ESG

Without getting hung up on the semantics, let’s look at it this way: ESG principles represent a shift in focus from short-term profits to long-term sustainability, in furtherance of our duty to conduct responsible business for the future sustainability of our people and our planet.

ESG is a broad concept that includes environmental, social, and governance factors that can impact a company's long-term sustainability. Although debates about what exactly needs to be encompassed by each pillar (the E and S more so than the G) and that ESG is mainly about the E and S (see It’s Time to Focus on the G in ESG) are continuing, here are a few factors to keep in mind:?

• Environmental factors include issues like climate change, resource depletion, and waste management;
• Social factors look at how a company interacts with its stakeholders, including employees, customers, suppliers, and the wider community;
• Governance factors include ethics and values, board diversity, executive and employee compensation, transparency, and responsible lobbying.

The Key Drivers of ESG

The ESG agenda is being driven by three critical stakeholders: investors, consumers, and regulators. These stakeholder group are shaping the demand for ESG-focused practices and determining how quickly or slowly we integrate more sustainable and responsible business principles into our decision-making processes.

Investors are demanding ESG-focused practices from businesses because they believe that companies with strong ESG practices are more likely to generate long-term value for shareholders. Investors are increasingly looking for companies that are focused on long-term sustainability and responsible business practices.

Consumers are also shifting more towards expecting businesses to adopt more sustainable and responsible business practices as they attach greater priority to these criteria in their search for products and services. This means that companies that fail to incorporate ESG principles into their operations may be at risk of losing customers and market share.

Regulators are requiring businesses to report on their ESG practices and setting new regulations to encourage more sustainable and responsible business practices.

ESG Standards and Ratings

If you can’t measure it, you can’t improve it - Peter Drucker

Establishing ESG standards, measuring performance against those standards and quantifying the impact of that performance is far from formulaic and is highly complex.

Although some financial firms have developed ESG ratings and scoring systems, there remain many open questions around what exactly that ratings and scoring systems are measuring and what they truly tell us about a company’s operations (see ESG: A Compass Without Direction and another interesting article challenging whether highly-ranked ESG businesses are really more caring of the environment, more selective of the societies in which they operate, and more focused on countries with good corporate governance The False Promise of ESG).

The point I am making here, is not that ESG isn’t important, but rather that it gives us pause in terms of its effectiveness vis-à-vis certain underlying objectives (be that the climate crisis or increasing the cost of capital for companies that put profit before social gain).

Is ESG The Only Option for Sustainable Success?

For some companies ESG is the only option for sustainable success. For others, not so much. A key question is whether ESG proponents have a measurable effect on the ability of non-ESG firms to source capital? In my view, not yet.

In summary, despite the fact that there is often a lack of clarity around the definitions, applications and standards of ESG, which can lead to debates about what it really means, how it’s measured and what the ESG ratings truly tell us about a company, we can’t dismiss it and we shouldn’t dismiss it. Searching for a bright-line rule or definition will lead us nowhere. ESG topics are broad and complex, and although businesses should strive to stay focused on the substance of the core pillars, they need to keep flexibility in mind as they adapt their interpretation and application to their specific operations.

Ultimately, in my view the overarching guiding principle of ESG (however you choose to define it or measure it) is uncompromised: it is our duty to conduct responsible business for the sustainable future of our people and planet. By focusing on this guiding principle, businesses can create more sustainable operations that generate long-term value for all stakeholders.?