When I Point to the Moon, Don’t Stare at My Finger
As much a high-minded set of principles and a vehicle for change in its own right, Environmental, Social and Governance (ESG) assessment has now been transformed into an all-important, pervasive, and sought-after label for ethical investing in all corners of the financial services industry. ESG investing has evolved into a $35 trillion industry with global assets managed in portfolios labeled “ESG” expected to reach $53 trillion by 2025.
The evolution of ESG has been, in many ways, as much an evolution of positive intent as one of process and determination. If fostering real, positive, and measurable change is truly the primary and enduring purpose of ESG to an investor or financial institution, its evaluation is not as easy as it once was. There is now the danger that investors can become more focused on the outcomes of the constructs of ESG label or ESG scoring rather than actively confirming the intended positive impacts. This brings to mind the wisdom of one of my favorite proverbs: “when I point to the moon, don’t stare at my finger.”
The foundations of ESG are not new. In the years before ESG’s ascendance as the standard for ethical investing created by the United Nations in 2006, it was much easier to verify the success of these early examples of ethical initiatives. Responsible investing was at its heart a focused, positive force, often directed toward very specific arenas and issues. We saw the likes of divestment with South African businesses effecting real, verified change in the form of, and demise of, Apartheid. Similarly, singular causes such as global civil rights, the UK Miner Strikes of the 80s, and the Anti-Vietnam War movements of the US continued to champion social causes. There were divestiture campaigns supporting environmental causes such as Greenpeace, The Sierra Club, The Unleaded Gasoline lobby, and others. The “No Nukes” movements of the 70s were especially prescient given past and current events in Chernobyl and Zaporizhzhia in Ukraine.
In governance and employee welfare, trade unions, such as IBEW and the United Mine Workers, invested in health and housing programs for their union members. The enlightened Hershey, PA, “the Sweetest Place on Earth,” home of Hershey Chocolates embodies a shining example of a company investing in all phases of their employees’ lives (schools, hospitals, entertainment, etc.) as a principled approach toward employee relations and, ultimately, managed risk.
The intended goals for each of these examples were easier to verify because they occurred more singularly and episodically. As a principle, this meant simply doing the right thing with one’s investments for the right reasons. The UN COP26 Climate Summit, “Me, Too,” and Modern Governance Diversity and Inclusion are similar modern manifestations of these early ESG-like initiatives, often in the news today. Responsible investing still means doing the right thing when no one is watching. Now more than ever, though, it has become doing the right thing to get everyone watching and following a conscientious, ethical lead.
The concepts of sustainability and socially responsible investing provide a global framework for countries, businesses, and industries to effect real change. They provide a set of principles and an ethical investing framework. That said, as ESG has evolved from a general philosophy to a better-defined set of ideals and methodologies, it allowed the potential for drift from the original purpose. ESG began as a relatively activist and philanthropic concept, and in ensuring the success of ESG principles in these complicated times, achieving the intended goals now requires active and persistent evaluation and curiosity.
Methods and Methodologies: Consistent with Intended Purpose?
In the modern effort to align with the UN principles through formal institutional scoring and certification, there is the risk of dilution of ESG’s original purpose. The focus has shifted more pointedly toward satisfying the array of qualifications, regulations, measurements, and stipulations within certification programs themselves and in their respective methodologies.
The construct itself has the potential to create distance from the true evaluation of the intended change. This is akin to the student who is excellent at taking tests in the classroom but misses the mark in getting a useful education or better understanding of the world. Fulfilling a regulation without reminding oneself adequately and consistently of the rationale behind ESG reporting can be flawed, even after the ESG qualifying regulation or reporting requirement has been soundly met.
Verifying ESG results is not always intuitive. For instance: in choosing between investing in a solar company or an oil company guided by ESG principles, which brings about more beneficial change? One would intuitively choose the solar company because solar companies do not ever create carbon emissions post-manufacture and delivery. The oil company, however, a known polluting carbon producer, when compelled to amend its processes either by improvements or reductions, by the adoption of new processes, or by increased sustainable energy initiatives, can reduce its net emissions and, in the end, be the better choice for bringing about the actual intended change. Less carbon enters the atmosphere potentially from the counter-intuitive choice. Dynamic ESG evaluation is key.
Not only is verifying ESG results not always intuitive, but it can fall short of the intended goal. ESG diversity scoring for the governance category is one example. A woman was once asked to relinquish her board of directors’ seat and was fined for misconduct. She was also prevented from holding a seat on the board for five years. During that time, the standards and initiatives of ESG overall evolved and were recalibrated. Despite this person’s history and reputation, her return to the board five years later caused her company’s ESG score to improve because she, as a woman, satisfied that aspect of the company’s governance gender scoring.
Often in the news now, ESG scores can be manipulated through “greenwashing.” As an example of differing standards skewing ESG scoring, the carbon footprint of Amazon was seen in one report as having a much lower ESG score than Walmart, despite it being a larger company. With further examination, activists found that the ESG scoring for Amazon did not include the carbon emissions of oceanic shipping in its supply chain evaluation, which was included in Walmart’s ESG evaluation. With so many ESG evaluation and scoring methodologies comes the possibility of systemic flaws if one does not examine all underlying elements of the criteria and the results on a ‘like-for-like’ basis. A company can “cherry-pick” a methodology that yields the better score, if so inclined.
Real Change Requires Active Evaluation
Real lasting change through ESG processes is not merely the satisfaction of constructs and checking of boxes. Filing reports, filling out forms, earning certifications, satisfying investor reporting requirements, applying analytics, and displaying documented compliance are crucial parts of the compliance process. However, genuine and realized change means verified and well-examined change that requires continual reevaluation and adjustment.
There is a variant of the opening proverb that adds nuance. “When I point to the moon, do not confuse my finger for the moon.” In the context of ESG, it is not sufficient to merely cloak and absorb oneself in ESG scoring and certification when confirming intended goals. Real change requires a more active evaluation process now more than ever before. Responsible investing guided by ESG principles must yield real, verifiable change to continue as a program with any lasting meaning.