A Short History of "ESG"

Today marks the twentieth anniversary of the first use of a curious term: ESG. Who Cares Wins was a pioneering report produced by the UN Environment Programme , funded by the Swiss Agency for Development and Cooperation . It was a rallying cry to the investment world, calling on markets to “better integrate environmental, social and governance issues” into decision-making.

ESG has been so successful in financial markets because it’s based on an investment rationale. As the 2004 report set out: “companies that perform better with regard to these issues can increase shareholder value by, for example, properly managing risks, anticipating regulatory action or accessing new markets”. Yet right from the outset, ESG also held promise of a greater good: a belief that finance could make a “contribution to sustainable development”. This was rooted in a long history of business and investors considering wider responsibilities to society. Yet as ESG ascended, it was this focus on financial relevance that came to dominate. Where did the term come from, and why was it so successful?

ESG as a very old new idea

The idea that business has a role to play in society, and purpose and ethics matter, has a very long history stretching back millennia . The role of investors, as owners of the firm, in stewarding good governance and expressing views on social concerns has also been around for centuries.

In my new book Measuring Good Business , I chart the history of shareholder activism from the seventeenth century onwards, the rising awareness of social and environmental issues in the twentieth century and what became known as socially responsible investing (SRI). I was able to trace the first ever corporate sustainability report to 1649 .

Up until ESG came onto the scene, most reporting focused on balancing a wide range of different constituency interests. Responsible business was all about playing a part in society, weighing up the needs of employees, communities, customers and management. For example, when Shell produced one of the earliest reports in 1998, it opened with the words: "This Report is about values" in response to rising interest in how multinationals were "overly concerned with profit and failing to take their broader responsibilities seriously".

Shareholder Capitalism changed the narrative

ESG’s birth in 2004 took place within a changing context of late twentieth century capitalism. The 1950s to 1970s had marked a period of rising concern around the social role of business. From US race riots to the Vietnam War, large companies were increasingly being asked to account for their impacts. Then rising inflation and stagnating returns in the 1970s impaired corporate profitability. This created a period of deregulation followed by explosive growth in capital markets during the 1980s. Milton Friedman’s famous critique that “the social responsibility of business is to increase its profits” became widely embraced in business schools and the corridors of power.

Shareholder capitalism had arrived. The Chicago School economists advanced free market ideas, taken up with gusto by Ronald Reagan in America and Margaret Thatcher in the UK. The new discourse, that became known as neoliberalism, promoted high levels of deregulation and privatisation, trusting the markets to deliver for all.

Up until the 1980s, the litmus test for a ‘good’ firm had been a complex balance of different constituencies, mediated by management and the board. But under the maximising shareholder value narrative, there was a much simpler test for a good firm: a rising share price. You didn’t need to calculate complex social accounts to figure out who was doing good. You could just look for an increasing stock market price.

So ESG was born into the advance of a particular school of economics. It’s clever repacking of an appealing offer to investors – complete with investment rationale – was timed to perfection.

June 2004: the first use of ESG

At 9.30am on 24 June 2004, Kofi Annan stepped up to the microphone in the Delegates Dining Room at the United Nations in New York. The United Nations Global Compact Leaders Summit was a gathering of some 500 representatives from business and civil society. It marked four years since the voluntary collaboration between companies had first started. The conference saw a host of speeches and pledges, but what we’re most interested in here is a particular report where a curious new acronym was used for the very first time.

“Who Cares Wins: ?Connecting Financial Markets to a Changing World; Recommendations by the financial industry to better integrate environmental, social and governance issues in analysis, asset management and securities brokerage ” (to give it its full title) was endorsed by firms including 荷兰銀行 安盛 , Banco do Brasil , Sarasin & Partners LLP , 法国巴黎银行 , 瑞信 , 德意志银行 , 高盛 汇丰 , 摩根士丹利 , 瑞银集团 and Westpac . ?It advocated that social and environmental performance should be a fundamental component of investment risk.?

Two new reports on this topic were published that day. A second report delved into the finances but had a much less catchy title: The Materiality of Social, Environmental and Corporate Governance Issues to Equity Pricing . (This second report didn’t actually use the abbreviation ESG).

Anthony Ling, Managing Director at 高盛 , stood up to present Who Cares Wins. He set out “a serious statement of intent” by the finance industry to view "environmental, social and corporate governance issues" as vital to healthy financial markets.? He spoke of ESG topics as a “vital aspect of overall management in the new global world, and the prize for getting them right was increasing”. Intriguingly, he also noted a “yawning chasm” between investment needs and current corporate disclosures. Although perhaps no longer a chasm, that gap between market needs and corporate data still rings true twenty years on.

Meanwhile, the UN Environment Programme (UNEP) held a press conference to mark the occasion. UNEP Executive Director Klaus Toepfer answered a series of questions from the assembled media. How can financial firms consider ESG when their aim is to make profits? What evidence was there that ESG affected valuations? Was the data consistent and transparent enough to enable ESG investing? What role did regulators need to play? Such questions would continue to be asked regularly over the coming decades.

ESG Terminology

Although the idea of environmental, social and governance metrics had been around since the early 2000s, Who Cares Wins was the first report to publicly package them together into the expression ESG. ?

The acronym has been attributed to Paul Clements-Hunt , a Brit who pinned down the expression the previous month whilst leading the team working on the report inside the United Nations Environment Programme Finance Initiative (UNEP FI) .

The success of Who Cares Wins, and ESG as a catchy term, lay in the bringing together of two fields. Governance was relatively familiar. Investors were comfortable asking companies about their boards and structures of accountability and decision-making. Bringing this G together with the more novel S and E created a pithy package that was accessible to the somewhat conservative world of finance.

Yet this also sowed seeds for confusion later on. Because whilst the ‘E’ and the ‘S’ are external to the business, ‘G’ is entirely internal. Governance is about management and implementation, just like operational excellence or a great culture. Social and environmental issues are about people and the big wide world out there. Yet the idea of looking at internal governance mechanisms alongside the external context has stuck. And governance mechanisms (like board accountabilities) are very good measures of assessing the implementation of the ‘E’ and ‘S’.

Another expression that has fallen out of favour is “non-financial”. This term had been around since the 1990s. It came from management studies that wanted to refer to business looking beyond financial metrics to aspects like customer satisfaction and product quality. Hence non-financial was often used interchangeably with ESG in the early 2010s. For a long time, non-financial reporting and non-financial metrics meant social, environmental and governance aspects – beyond the core financial measures of the accounts. But given the advancing argument that ESG was important precisely because it fed back into financial performance, “non-financial” has rightly fallen out of favour. The investment rationale and business case has been fundamental to the rise of ESG.

ESG’s business case

Who Cares Wins recognised the rising investor interest in the link between ESG issues and “overall management quality”. Crucially, it identified an “investment rationale” that was based on an emerging “business case at the level of the company”. The idea that you could track and measure this commercial value at a firm level was a departure from the past. In earlier eras, the economic advantage of responsible business was that all businesses benefited collectively. Most accounts from the 1970s, for example, reference this wider aim of social reporting. It’s wasn’t an individual business that directly benefitted from social responsibility, but the collective whole: society and the economy at large. So there was a business benefit, but it was rarely spoken of as firm-specific.

ESG was based on the idea that individual firms could outperform. That meant investors could try to measure it. This is what finance needed: a use case to pick stocks that would beat the market (and, later, lend money to less risky firms). Advocates promoted the idea that by screening companies with ESG criteria, shareholder value could be enhanced in the long run. Who Cares Wins described ESG as value driver – a tool to spot risks, reduce costs, innovate new opportunities and enhance brand and reputation. This resonated as it fitted perfectly with the narrative of the day: maximising shareholder value.

With hindsight, 2004 was something of a turning point. At the dawn of the twentieth century, socially responsible investing (SRI) was an ancient but relatively small niche (around $2 trillion). Yet its objectives were principled. Rather than processes to improve returns, SRI was about outcomes and impacts. Yet it faced many of the same issues that ESG would stumble into. In a report from 2004, the pioneering environmentalist Paul Hawken described the SRI industry as “closed, proprietary and secret”, based on “black box” methodologies, inconsistent metrics and “vague and indiscriminate” terminology that created little real-world impact. Over the following twenty years, exactly those same charges would be laid against the new world of ESG.

SRI’s focus on impact – not the investment case - was typical of how many organisations considered these issues at the time. The Global Reporting Initiative (GRI) , established in 1997, was hailed by Kofi Annan for “fostering corporate transparency and accountability beyond financial matters”. The United Nations Global Compact was set up as a set of principles that acknowledged “universal values” and business as part of the “fabric of communities”. In 2005, the World Economic Forum defined responsible investing as “investing in a manner that takes into account the impact of investments on wider society and the natural environment”. Note the word impact there – it meant impact on the world, not the business. Similarly, the US SIF - Social Investment Forum - defined its field as considering the “social and environmental consequences of investments”.?

Yet ESG helped the market perform a tumble turn. Rather than impact on the world, social and environmental considerations became about the impact on the business. ESG issues mattered because they mattered to investment returns.

The narrative that ESG could drive shareholder value rubbed off onto the corporate sector. Dan Esty and Andrew Winston published their influential book “Green to Gold” in 2006, detailing a litany of business benefits. By 2009, companies such as British Telecoms were proclaiming: “fortunately we don't have to choose between what's good for our business and what’s right for society and the planet". The same year, IT firm Xerox described a similar win-win: “we don’t have to choose between the environment and profit. We can do both”. Reporting on the first year on progress on the Unilever Sustainable Living Plan in 2011, Paul Polman captured the zeitgeist: “Growth and sustainability are not in conflict. There is no inherent contradiction between the two. In fact, in our experience, sustainability drives growth”. This was quite different from how earlier generations had talked about the rationale for business’s responsibilities.

ESG would never have been as successful as it has been without this strong business case. The movement brought a nascent investment rationale out of the shadows and into the spotlight. It made the business case so glaringly central that the other aims – the idea of business acting for ethical reasons, or bettering the world as a valid aim in of itself – played second fiddle. As ESG stormed into the mainstream of finance in the late 2010s, its entire premise was financial relevance to investors.

ESG ascends with a financial promise

Within weeks of the 2004 Summit, the UN Environment Programme had reconvened investors and launched a new “Responsible Investment Initiative”. Two years later, the Principles for Responsible Investment (PRI) was born. This re-used and reinforced the expression ESG as firmly about benefiting financial markets. PRI was created with the insight that “ESG issues can affect the performance of investment portfolio”. The Principles promised “a framework for achieving better long-term investment returns and more sustainable markets”. Investors rapidly signed up.

Beyond the UN-backed conferences, the term ESG was somewhat slow to take off. It first appeared in the New York Times in April 2007, in an article around business’s role in tackling climate change. That same year, WWF used the words ‘ESG’ to describe corporate sustainability performance in the luxury goods sector. By 2008, companies like AIG had begun using the term as part of their CSR reporting.?

Following the Global Financial Crisis of 2007–2008, the idea of leaving it all to the markets came under scrutiny. Business was under fire for short-term profiteering, spectacularly misjudging systemic risks, eroding public trust and negating their wider social role.

The key that unlocked success for the ESG movement was the win-win proposition. By linking responsible business to shareholder value, all the problems of the world would be solved together. Companies and their investors could rebuild trust and be seen as responsible citizens whilst also growing the firm’s valuation. Investors could launch new products, charge larger fees and make more money from backing the winners.

There was a marked shift underway from corporate social responsibility (CSR) and sustainability towards the new buzzword. ESG was seen as more rigorous: it appealed to investors precisely because it was framed as all about long-term financial value. At the same time, climate change was becoming recognised as the signature issue that presented a financially material risk to companies. This laid a foundation stone for measurement. The FSB Task Force on Climate-related Financial Disclosures (TCFD) was created in 2015 by the Basel-based Financial Stability Board (FSB). In 2011, the Sustainability Accounting Standards Board (SASB) was founded to develop the metrics that financial markets needed. But one criticism has been the number of different frameworks. This was because there were so many market and non-market needs. By the late 2010s, there were around 600 different reporting frameworks and standards in existence around the world.

In 2018, ESG crossed the Rubicon: it entered what’s called the “late majority” stage of an innovation. That year, surveys revealed for the first time an astonishing fact: a majority of asset managers claimed that they were using some form of ESG in their internal processes. ESG had become part of mainstream finance in an incredibly short space of time. Still the pace didn’t slow. Two years later, in 2020, the Global Sustainable Investment Alliance (GSIA) estimated that more than one in three dollars in major markets was invested under some type of ESG mandate. Four in five professional investors said ESG was important to their decision-making. Although it is hard to tell from such figures how far ESG was substantively shaping investment decision-making, the concepts and data had become widely accepted by the start of the 2020s. Even the pandemic failed to stop the rush as new sources of data – particularly around social issues like inclusion, health and well-being – fuelled the rise.

Client demand for ESG products propelled this gold rush. By 2022, investing within an ESG framework had become the fastest-growing segment of the asset management industry. Funds were being rebranded and relaunched under ESG and sustainable labels. Around this time, ESG products had become so popular that it was estimated that two new ESG funds were being launched every single day. That’s completely insane! Even the twists in the markets following Russia’s invasion of Ukraine – a rising oil price, elevated interest rates and the return of inflation – failed to stop the ESG party. True, ESG funds have underperformed recently. There is evidence of outflows in many markets. But despite all the challenges and the backlash in the United States, ESG has continued to grow as a global market.

What is so extraordinary looking back is the speed of the mainstreaming. During the 2010s, we went from ESG being a small niche that most in finance knew little about to a sea change in attitudes. Everyone wanted a piece of the action. Why the rush? Because there was money to be made. For the fund management industry, ESG became a new source of revenues. Studies show that brand and reputation overtook improved long-term returns as the main motivator for ESG investing. Labelling a fund as ESG allowed for higher fees to be charged. Hence the major challenge of greenwashing: it’s increasingly difficult to sort substantive investment products from flaky ones.

ESG has created a profound legacy. The investment world has woken up to many of the big challenges facing the world. Pockets of finance – like impact investors – are starting to play a substantive role in the much needed transitions. The rise of investor interest has driven more companies to pivot their sustainability strategies towards meeting investor needs and responding to ESG data requests. Yet huge challenges remain. For one, what happens when there isn’t a business case? The limits to markets are rarely discussed in ESG World . As ESG shifts from a voluntary to a mandatory exercise, new regulations are prescribing the key terms and defining the metrics to report on. That will help with the greenwashing. But there will be more twists and turns ahead. The next 20 years could prove just as transformative.

This article was adapted from my new book Measuring Good Business: Making Sense of Environmental, Social and Governance (ESG) Data (Routledge, 2024).

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