The Future of ESG?

ESG emerged as an investor framework that promised simultaneous ROI and environmental and societal good. ESG performance was heralded as a key indicator of long-term resilience and therefore capital was expected to flow to organisations with good ESG records and away from those with the less good ones. The market itself would be the means of change. And from the investment community, the language of ESG spread apace throughout the wider business community.

The push-back against ESG has begun at source – in the investment community, and based partly upon underwhelming performance by ESG funds. Last year, it was reported that funds of equities, debt and other asset types dedicated to responsible investing posted net outflows globally of $108 billion to the end of September. While more broadly, of course, the bigger effects are not evident – the world is simply not on track to meet, among other things, the UN’s Sustainable Development Goals or the Paris Agreement. 

A critical assessment in the FT espouses the view that ESG investing rests on “weak conceptual foundations and should be viewed suspiciously by investors who seek adequate returns, and by citizens who want real rather than cosmetic change”. So, given these signs of a possible tempering of attitudes towards ESG, in what ways if any does the framework remain useful for CSO or other senior sustainability executives?

A framework for materiality 

ESG as a framework remains useful for CSOs and organisations as a map of those ‘intangible’ factors that are important in stakeholder management and business strategy. This map allows organisations to conduct the materiality assessments that determine where they need to focus for greatest impact (in the case of double materiality, in both managing outside-in risk and inside-out effects), while ensuring they have at least a point of view or holding position across all issues. ESG frameworks, while differing slightly across organisations and ratings agencies, also offer a degree of consistency and apparent rigour to the management of stakeholder priorities and organisations’ societal impact.

I think ‘ESG’ has been helpful in driving the agenda. And in being clear that it’s not just about the planet or philanthropic stuff, but we’re talking about a wide set of topics. So, it is a convenient shorthand I find for us to say it is this set of topics – it’s been a useful framing for us.

A return to the language of sustainability  

ESG factors will also remain vital in assessing organisations’ long-term value. Alex Edmans of London Business School makes a strong case for ESG being nothing special: “Considering long-term factors when valuing a company isn’t ESG investing; it’s investing". Going on to say that a, “company’s relationships with its employees, customers, communities, suppliers, and the environment are highly value-relevant; there’s nothing particularly cultish ... in considering them". For many of the CSOs that we spoke to, ESG reporting will certainly continue to be a key feature of investor relations. Although ESG reporting is in some cases seen as a complicating factor, with a proliferation of reporting demands and ratings agencies. These often employ inconsistent methodologies, provide counterintuitive rankings and offer little guarantee of real impact on the important topics covered. Hence an increasing association of ESG ratings with greenwashing. And indeed, they are often not even relied upon by investors, who are running their own models.

“ESG has almost become a phrase that is associated with ratings. And you can look at one rating and compare it to another and a company can be at the top of one and at the bottom of the other; the methodology is so inconsistent. I think ESG ratings are basically spiralling into a lack of credibility, into distrust frankly.” 
“There’s a real danger that sustainability teams just spend all their time reporting, crunching numbers, and forget that actually we’ve got to decarbonise the business.”

 Investors, bond holders, shareholders are interested in risk management and assuring return on investment, so that’s the ESG side of sustainability for me. The sustainability side of sustainability is more about our clients and our government contracts where they’re not so interested in a return on investment as in the value generated to society. So, there’s overlap but they’re two sides to the materiality assessment.

 Another criticism of ESG frameworks is that they tend to imply an equivalence across the pillars and dimensions of E, S and G. There is a danger that climate change, for example, becomes seen as one among many issues, when really all organisations need to be addressing this with the upmost urgency. Allocating the right amount of resource across issues should be addressed by good materiality assessments, but this can be challenging given the range and sometimes tension between ESG factors. 

What’s also conceptually challenging for many organisations is the inclusion of the G, governance, within the framework. Governance often sits in a different part of the business to the E and the S (in legal, for example), and can been seen as something more fundamental, encompassing all of issues grouped within ESG. The B Corp movement is already rooting ESG in commitment at the level of corporate governance: B Corps are legally required to take into consideration anyone that is materially affected by that company’s decision-making, like workers, customers, local communities, wider society and the environment.

To me the G has always been there. People have often said I know we say ESG but really it is G and that E and S under it, so it is all about how we have strong governance across the company and if you have strong governance then you probably are including E and S in it.

For other stakeholders than investors – e.g. customers, employees, government and third sector – many CSOs predict a return of the language of sustainability. Including associating sustainability with good governance. The benefit of this for organisations is that they can potentially tell more distinctive stories, while focusing resources where they can have the greatest real impact and recognising the increasing interconnectedness and complexity of ESG. 

“I do think even then it tends to separate us into these silos of environment, social, governance, where actually it’s all completely interrelated, which is why I think sustainability as a term is also important because it recognises that interrelatedness.” 

The danger for stakeholders would be the potential abandonment of some of the most appealing elements of the promise of ESG investing frameworks: their comprehensiveness, their implication of scientific rigour and measurement, and their consistent lens applied across organisations. And, in turn, the prod that ESG has undoubtedly given organisations to begin making the deep changes required by the planet and society. 

To avoid a return to CSR then, what will fill perform these roles? For many CSOs, the answer would be that the time is right for stronger regulation.

Table of contents

1. Introduction: ESG Council Report 2023
2. Chief Value Creator?: The changing role of the Chief Sustainability Officer (CSO)
3. What is driving change: The role of stakeholder management
4. Building an integrated ESG strategy
5. Doing well by doing good: Resilience, risk and the reputation value of ESG
6. The Future of ESG?
7. ESG - a time for leadership, focus and communication, but above all action.