Driving action against climate change has become a significant focus for companies across the globe. The rise of Environmental, Social, and Governance (ESG) factors has been instrumental in this. However, as ESG becomes more mainstream, concerns about its effectiveness and potential misuse are surfacing. Are these strategies genuinely driving climate action, or are they merely a tool for companies to greenwash their operations? Let’s delve deeper to clarify the matter.
The Rise of ESG in Business Strategy
Over recent years, there has been a remarkable shift in investor acceptance and concern about climate change. Companies are now ensuring that positive impacts on climate change mitigation are at the core of their strategies moving forward. This attention to ESG has been influential but has also come under scrutiny from investors and business leaders who question its efficacy.
While many perceive ESG as a gauge of a company’s impact on the environment and society, businesses view it as an indicator to investors about their enterprise’s risks related to climate and more. This divergence leads to recent scrutiny. What the public desires is for companies to be held accountable for their impact, and what companies want is to demonstrate how they’ve minimised their risks. This dichotomy essentially outlines what the EU describes as Double Materiality.
Understanding Double Materiality
ESG is primarily designed to score a business on their risk factors (the left side of the double materiality image below), and not designed to provide insight into how their business impacts the environment and more (the right side of the double materiality image below). This distinction has been confusing to investors.
Organisations like EFRAG and SEC are undergoing public consultation on enhanced ESG investment practices and new reporting standards for business’ carbon impact in the form of Scope 1 (direct emissions), Scope 2 (emissions from electricity), and Scope 3 (indirect emissions) in an attempt to address this current issue.
The Threefold Challenge: Investor Risks, Climate Change, and Social Impact
Investors often struggle to decide what’s most important amongst reducing investor risks, combating climate change, and advocating for social impact. However, the buildings industry has been ahead of the curve in this regard. The consensus is not about choosing between the three but acknowledging that smart strategies can and should address all three social, environmental, and financial risks and impacts.
Building a Greener Future
Buildings are a fantastic example of where companies can invest to both reduce their impact and reduce their risks, attacking both sides of the double materiality equation simultaneously. Reducing a building’s carbon footprint not only fights climate change but also reduces future regulatory risks. If the retrofit is carried out with the community in mind, it can address local societal needs.
An excellent demonstration of this is the Western North York Community Centre in Toronto, Canada. This facility was designed to achieve a net-zero status, reducing energy needs and future operating costs, while addressing the local community’s need to bridge two suburbs together.
Unlocking the Potential of ESG
ESG still has the power to drive change, if approached with the right intent. To unlock potential profits and reduce the material financial risks that ESG investors hope businesses can achieve, looking at investments from both risk reduction and impact perspectives is crucial.
The unprecedented growth in investor demand for ESG investments has proven that there is a desire for climate change accountability. This accountability is likely to come soon in the form of new reporting requirements. The companies that address these issues comprehending not just how their bottom line is affected, but also how their business impacts stakeholders will distinguish them from the rest.
The Evolution and Criticisms of ESG
Since the introduction of the acronym “ESG” in 2005, it has progressively grown in popularity. However, despite the rising profile of ESG in investments, the rate of new investments has recently been falling. This decline has led to a fivefold increase in internet searches for ESG since 2019, indicating a heightened interest in this area.
The four main categories of criticisms against ESG include doubts about its desirability, feasibility, measurability, and relationship with financial performance. Critics argue that ESG distracts from the primary function of businesses, i.e., maximising profit. They also maintain that the implementation of ESG is too complicated and cannot be accurately measured. Lastly, they question if there is any meaningful link between ESG and financial performance.
The Role of ESG in Driving Climate Action
While ESG’s role in driving climate change action is under scrutiny, a record 97% of respondents to the EY Global Integrity Report 2022 agree that integrity is essential. However, there is a growing “say-do” gap between rhetoric and reality, which increases opportunities for greenwashing.
Greenwashing in this context can be seen as a disconnect between words (what an organisation says) and actions (what it is actually doing). Consequently, senior management and board members should ensure they can back up what they are saying and consider the potential commercial, reputational, legal and financial risk of making statements they cannot support.
The Climate Reporting and Crises
Corporate reputations and the careers of CEOs are quickly destroyed by public disclosures of a say-do gap. Companies facing scrutiny on disclosures, deeper analysis between peers and more cross-border enforcement should understand how they can validate (through strategy, data, and reporting) public-facing statements.
Integrity can be a difficult concept to define. It’s about making the intangible tangible, committing to the interdependence of business and society by embedding integrity into the culture and behaviours of the organisation. But fewer than half those ESG surveyed for the 2022 Global Integrity Report are using the basics of integrity enhancing measures.
The Impact of Regulatory Changes on ESG
Regulatory changes are also impacting the ESG landscape. From Argentina to the United States, regulators worldwide have implemented or proposed rules aimed at advancing sustainable finance. These rules cover everything from driving transparency in corporate supply chains to defining what an environmentally friendly activity even looks like.
The European Union, in particular, has been among the most prolific rule makers. The bloc began rolling out sustainability rules for asset managers as part of a series of directives aimed at ensuring it hits its climate targets and helps rein in global warming.
The Backlash Against ESG
Despite these advancements, ESG has faced significant backlash. Political theatrics, mostly in the United States, make up the first form of backlash. Some right-wing governors and attorneys general are unhappy with investors who have set goals to get to zero carbon emissions in their portfolios. They argue that the investors are progressives and “politically motivated, anti-free market, anti-family.”
The second form of backlash against ESG is from the investment community’s sceptics. They question ESG investing, asking, “Will ESG funds outperform ‘regular’ funds?” With the inherent levels of irrationality and unpredictability in the stock market, asking “Does it outperform?” is a bad question.
The Real Work of Sustainability
The real work of sustainability — not just filling out endless ESG questionnaires — will continue. Companies pursuing a sustainability strategy will be working toward zero carbon, addressing human rights issues in their supply chains, innovating products and services to satisfy customers that want more sustainable options, and much more.
In conclusion, while ESG has been a powerful tool in driving climate action, there are concerns about its misuse for corporate greenwashing. However, it’s crucial to remember that the real work of sustainability goes beyond ESG and entails a commitment to a broad range of environmental and social impacts. As we move forward, the focus should not solely be on the criticisms and potential misuses of ESG but on how we can refine and improve these strategies to drive genuine, impactful change.