What is ESG? And does it matter?

June 30, 2021
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It can increasingly feel that the world of Sustainability is turning into an alphabet soup – SDG, ESG, CO2 PPM, TCFD, SFDR, COP26 and no doubt at some point I will touch on these and others over these thought pieces. One of those acronyms – ESG - is gaining increasing coverage and traction, and is being equally declared as the saviour of the planet and capitalism, and criticised as the engine of greenwashing and ‘greenwishing’ by organisations who want declare their green credentials without getting beyond the PowerPoint and press release.

But it is worth as pause to explore what ‘ESG’ is (and isn’t) and work out if it matters in the work of Sustainability and the change required for us to live within planetary boundaries. Spoiler, in my view, the answer to that question is – Yes, No, and Yes. Firstly, what is ESG?

What is ESG?

ESG stands for Environmental, Social and Governance factors (not Government peeps, not Government, as I see it referred to every so often) and the term has is history in the investment industry where ESG factors codify the set of standards an organisation should adhere to be considered socially responsible and be attractive to investors who wish to invest to socially responsible portfolios (cue another acronym SRI).

I’m not going to write extensively on the ins and outs of ESG investing (MSCI have done that more fulsomely than I ever could here). But it is worth breaking down the acronym a little more, to understand what we do include in Environmental, Social and Governance factors:

Environmental – To produce anything (yup, pretty much anything) we take resources from the planet and pump materials back into the planetary ecosystem. This causes significant environmental issues like climate change, resource depletion, waste, pollution, deforestation and bio-diversity loss. When we think about improving our Environmental impacts, we are referring to actions like reducing carbon usage, extracting less, moving to circular economies which keep us within sustainable planetary boundaries- more on these to come, as understanding these ‘planetary boundaries is vital to the understanding of Sustainability.

Social – ‘S’ factors recognise companies have a responsibility for their impact on societies in which they operate as well as their employees. Social include human rights, labour standards in the supply chain, any exposure to illegal child labour, and more routine issues such as adherence to workplace health and safety. A social ‘score’ also rises if a company is well integrated with its local community and consumers and therefore has a ‘social license’ to operate with consent.

Governance (not Government!) - Governance is the control and management mechanism an organisation puts in place in relation to factors such as bribery and corruption, tax, executive remuneration, shareholders’ voting possibilities and internal control. One way of ensuring this is to focus on increasing transparency and openness in contacts between the company and shareholders on issues such as board composition and shareholder rights. A well-defined corporate governance system can be used to align interests between stakeholders and can work as a tool to support a company’s long-term strategy.

Note well the usage of the phrase “long term” in that last sentence. All these ESG factors are in service of creating companies that are focussed on long term, sustainable contributions that are within planetary boundaries.

What does any of this matter?

I wrote this article in response to three triggers:

  1. An excellent article by Kenneth Pucker, Timberland’s former COO, in HBR which argues we are slightly missing the point on all this sustainability reporting and investing,
  2. A provocation on Linkedin (from Jan Levy) that suggests we are confusing and conflating ESG and Purpose, and,
  3. I work in the dual realms of Sustainability and HR/Talent/Purpose and realise that ESG and Sustainability - in its broadest sense – simply isn’t understood by most leaders on boards in organisations as its seen as niche and not in their remit

So, to my Yes – No – Yes spoiler I pre-trailed earlier…

Yes – ESG matters.

If you work in a company, you need to understand the environmental and social impacts you have and ensure your ‘hard’ and ‘soft’ governance (culture, processes, systems) is managed to serve a long-term sustainable strategy.

If you a bank lending to or investing in a company, you need to be confident that loan or investment can provide you a return. Investing in a fishing company that just fished the last fish in the sea, is not going to give you a sustainable return, even though their financial accounts will not show you it’s inevitable and tragic lack of sustainability.

If you are a regulator or statutory body, you care about risk, resilience, adaption, and stability. You care about ESG, as these factors point towards long term stability.

No – ESG can be a distraction and at worst misleading.

The debate about ESG investing and greenwashing is heating up, as more and more companies focus on the metrics required to ‘prove’ you have high ESG creds. The reporting standards are currently disparate and in places contradictory. There are moves afoot to increase reporting standardisation with ever more convergence in the ESG reporting space and the Task Force on Climate-related Financial Disclosures (TCFD) is increasingly necessitating that companies accurately disclose their risks related to ESG.

But poor-quality data remains a big issue and with more and more net-zero targets being set by firms and limited ability to hold those companies and targets to account, and lack of confidence is undermining real progress on sustainability.

Yes – ESG is an important prompt to help us reframe what is often not seen in the traditional economic model.

More importantly, ESG factors asks us to include these lovely ‘externalities’ that our existing economic model excludes and trigger us to think about what our long-term strategies are really in service of. If we need to account for Environmental, Social and Governance factors, we need to ask the question of how our corporate institutions make a more positive contribution to the world, beyond a pure ‘profit maximisation’ mindset. That means changing the paradigm and system. That means, the leadership and mindset we need to take us into a new sustainable future need to be addressed. Donella Meadows, the doyen of systems thinkers, tells us some of the most important levers we have to generate change, points us to “the mindset or paradigm out of which the system – that its goals, power structures, rules, its culture – arises”.

In summary ESG – WTAF? ESG – JFDI!