The breadth of ESG is no weakness

The Economist magazine’s cover feature on 21 July was headed “ESG: three letters that won’t save the planet”. The accompanying report argued that growing investor pressure for businesses to show their environmental, social and governance credentials has created a “dizzying array of objectives” that are unrealistic to achieve.

To tackle the medium-term existential threat to the planet, the authors said, businesses and the investors who support their survival and growth, must abandon the social and governance metrics and even most of the environmental ones, to concentrate on curbing carbon emissions.

It wasn’t that long ago that The Economist argued that emissions were irrelevant to business and finance, so forgive me if I say that they are throwing the baby out with the bathwater here.

There’s no doubt that acting to limit climate change should be an always-present priority for us all, but the idea that business should behave as though it’s the only sustainability measure worth pursuing seems draconian.

The point about the diluting effect that comes with pursuing too many objectives is well made. The safety director at one of the largest construction companies working on UK infrastructure projects once lamented to me in an interview that the Highways Agency’s latest health and safety plan, which he was obliged to sign up to as a contractor, had no less than 122 objectives and felt “more like a shopping list than a strategy”. Setting too many priorities can be as nugatory as setting none.

At the same time, we are dealing with complex issues with no definitive regulatory framework against which to standardise goals. Some objectives may be relevant to investors, others may not. They may be important for clients or a broader licence to operate, for example.

But there are well-tested ways for companies to avoid the temptation to “collect the set” of environmental and social initiatives. Most corporations base their sustainability programmes on materiality assessments, asking their stakeholders: employees, customers, suppliers, investors – even campaign groups, where their organisation could make most positive difference. The long-list may have tens of items, from anti-corruption to pollution control but most companies rightly decide to double down only on those that are rated highest by their consultees. The rankings, which can vary widely by sector, give them a clear order of priorities. There may be examples of ESG-focused investors pressing businesses to ignore their won materiality assessments in favour of some other agenda, but I haven’t heard of them.

The Economist’s argument that emissions reduction should be the only game in town risks ignoring the value of the other ESG strands businesses are judged on now. The magazine’s leader dismisses the social plank of ESG as follows: “In a dynamic, decentralised economy individual firms will make different decisions about their social conduct in the pursuit of long-run profits within the law. Tech firms may appeal to the values of young employees to retain them; firms in declining industries may have to lay people off.” That perfunctory dismissal of social sustainability ignores the promotion of workforce diversity, community engagement, or raising health and safety standards above regulatory minima. All of these and more have been pushed by investors’ agendas and led to real improvements in businesses’ social impact and broader success.

In the 1970s and 1980s some radical socialist groups dismissed attempts to even-up obvious social inequalities. Campaigns for women’s rights, ethnic minority rights, even efforts by trade unions to get employers to compensate their workers who had fallen from scaffolding or lost their hands in machinery – were dismissed as, at best, irrelevances which distracted attention from the need for a political revolution – which would sweep away all these inequalities at a stroke – and at worst actually putting off the national uprising by putting sticking plasters on a doomed capitalist system. The problem with this thinking is that it sells the present to pay for the future. So it is with ESG. If investors ditch all the other ESG priorities such as improving the health of their workers or reducing water use, just to hold business’s feet to the fire over decarbonisation, then in the short-term a lot of improvements for workers and communities may stall. And those goods will be sacrificed in the name of something which arguably would be better effected by other means.

Slowing climate change is so important that leaving it to the investment community to press organisations to act faster is too slow a lever. It also doesn’t act on SMEs, family-owned businesses and the public and third sectors. Pressing business to cut emissions is a role that best sits with government, which sets the framework in which commerce is allowed to operate without too much damage to the public good. In the UK, the government has got off to a slow start with the Streamlined Energy and Carbon Reporting framework setting emissions reporting requirements for larger organisations and the Energy Savings Opportunity Scheme, which requires companies to audit and report on their energy use. These need to be extended and harder targets mandated.

The other weakness in the argument that investors should put all their eggs in the emissions-reduction basket is that it assumes that in promoting ESG they are motivated primarily by protecting the planet. That may hold true for some of the major institutional investors, such as church pension funds, and even for some retail investors trying to do most good while growing their stocks-and-shares ISAs and retirement pots. But the biggest fund managers who employ stewardships teams to check the ESG plans and performance of the businesses they fund, don’t usually talk about the moral good. They say that good ESG management is a signifier of good management in general and more likely to generate reliable profits. As Larry Fink, CEO of fund managers BlackRock, which manages $10 trillion (£8.3 trillion) on behalf of its clients, put it in one of his public letters to CEOs: “a company cannot achieve long-term profits without embracing purpose and considering the needs of a broad range of stakeholders”.

The Economist suggests that “the link between virtue and financial outperformance is suspect”, and it’s true that there is mixed evidence – partly because most businesses managing with sustainability in mind have not been doing so long enough to generate a strong time series. But the point is that if the fund managers and institutional investors believe that good ESG management equals more reliable returns, that’s where they will put their money.

Ethical investment has been around at least since the 19th Century when members of religious groups including Quakers and Methodists avoided funding production armaments and alcohol production. But it was a niche activity until recently. ESG, applying high standards of conduct and sustainable management to all businesses and threatening to divest from those who are not willing to try to meet those standards, is still just fledging. There is plenty of room to hone it to increase its positive impact, but ditching it now in for a single-item responsibility agenda favouring decarbonisation is both unwise and unlikely to happen.

Guest blog written by writer, editor and speaker, Louis Wustemann