ESG Will Improve, With Cynicism, Critics & Critique
The concept of Environmental, Social, and Governance (ESG) has sparked a whirlwind of discussions and debates. Critics have emerged, and their voices have grown louder. So what next?
ESG is not only valid but desperately needed in our evolving financial landscape. Why?
The formalisation of the ESG concept is a relatively recent development, with measurement and framework adoption taking place over just a few years. Reflecting on this, one cannot help but wonder: if the ESG values weren't already enshrined in the broader fabric of human societies, we might have faced even more profound levels of anarchy and social unrest.
The common criticism revolves around the diverse metrics used to measure E, S, and G factors. Detractors argue that these metrics are distinct and cater to different needs. Well, isn't that precisely the point? Companies are multifaceted entities, and a one-size-fits-all approach simply won't suffice. ESG acknowledges this diversity and encourages a holistic assessment of corporate behaviour. The absence of consensus on what defines a "good" or "bad" company only underscores the complexity of the business world, making ESG all the more essential.
Critics also raise concerns about companies "gaming" the ESG scoring system. But should we throw out the entire hope on ESG, just because of potential loopholes in the frameworks ? Credit rating agencies faced similar issues in the past, yet we didn't abandon credit ratings altogether. Instead, we improved and refined the system. ESG deserves the same treatment.
Another accusation is that investors have overhyped ESG, likening it to past century’s financial innovations. Yes, there has been hype in the past without meaningful regulatory role, but that doesn't diminish ESG's legitimacy. We have seen overhyped technologies and financial products before, but that didn't invalidate the internet or social media or the concept of business diversification. ESG, like any other tool, needs responsible usage.
Furthermore, critics argue that ESG ratings vary significantly between vendors, making it challenging for investors to construct reliable portfolios. This variation, however, highlights the need for standardisation and transparency in the ESG rating industry, not the abandonment of ESG principles. It's a call for improvement, not a condemnation.
Lastly, some investors place their trust in regulators and institutions rather than corporate CEOs. While this trust is vital, it's not ESG's role to replace regulators. ESG complements their efforts by providing a means for investors to align their values with their investments. Regulators must strengthen their capabilities, but this doesn't diminish the need for ESG as a valuable decision-making tool.
Critics argue that ESG focused investments have not consistently outperformed traditional investment options, questioning the effectiveness of ESG as an investment strategy. However, it's essential to recognise that ESG's primary goal is not solely to maximise financial returns in the short term. Instead, it aims to deliver sustainable and responsible outcomes over the long haul. ESG investing is about aligning investments with values and contributing to a better world. It promotes responsible business practices, helps mitigate risks, and contributes to a more sustainable future, which, in the long run, can yield significant benefits for both investors and society as a whole.
Critics who rush to judgment on ESG’s effectiveness based on a mere decade of financial data are not only shortsighted but fundamentally misguided. ESG measurement is still in its evolutionary phase, and its global adoption is marked by significant asymmetry and regulatory disparities. To dismiss ESG’s potential impact on investments based on this limited timeframe is akin to writing off the internet in its early dial-up days or declaring electric cars impractical in their infancy.
The global landscape of ESG measurements remains inconsistent, with varying standards and methodologies across different regions. This creates an environment where ESG arbitrage across regulatory boundaries can occur, causing discrepancies in reported performance. Such disparities can cloud the true potential of ESG investments, making it crucial to allow more time for standardised and harmonised ESG metrics to develop. A meaningful ESG rating system should be capable of delicately balancing the nuances of diverse social and cultural norms, capturing what constitutes acceptable good behavior across different contexts. This adaptability and inclusivity are crucial for ESG to serve its purpose effectively in our ever-evolving world.
Indeed, calling it quits on ESG at this stage would be profoundly premature and a disservice to society as a whole. The philosophy underlying ESG, which emphasises not just being profitable in financial terms, but also doing good for the planet and society, is an imperative for our times.
First and foremost, the urgent need for ESG is rooted in the challenges we face today. Climate change, social inequality, and corporate misconduct are pressing issues that require immediate attention. ESG offers a structured approach to addressing these challenges. It prompts companies to consider their environmental impact, contribute positively to society, and uphold strong governance practices. Without ESG, these issues could continue to escalate, with potentially devastating consequences.
Furthermore, ESG aligns with changing consumer and investor preferences. A growing number of consumers want to support businesses that share their values and prioritise sustainability. Investors, too, are recognising that ESG factors can impact a company's long-term financial performance. As a result, companies that embrace ESG principles are more likely to attract capital and customers, giving them a competitive advantage in the marketplace.
ESG also fosters innovation and resilience. Companies that integrate sustainability into their strategies are often better prepared to adapt to changing market conditions and regulatory requirements. They are more likely to invest in innovative technologies and practices that can lead to long-term cost savings and revenue opportunities. In this sense, ESG is not just a set of checkboxes but a catalyst for positive change and long-term value creation.
Srinath Sridharan - Author, Policy Researcher & Corporate Advisor.
Twitter : @ssmumbai
&
Shailesh Haribhakti, Independent Director on corporate boards.
Twitter : @ShaileshHaribh2
