Spurious Sustainability?

How the ambiguous definition of ESG is misleading investors and undermining institutions.

By Edward Hope

The evolution of the acronym ESG, starting in the 1960s, has been a long and industrious one. It first emerged as ‘socially responsible investing, subsequently evolving into the modern-day ESG term we know today, in 2004. Its true meaning, however, is lost in a litany of misuses and incorrect interpretations, which means that those who do care about its implications, as a term and concept, feel the need to preface their use of it with intensifiers. The results of this are that an accurate, consistent level of sustainability and social justice is never conveyed to investors, and often, surprisingly, the truth is irrelevant to investors anyway

ESG, meaning Environmental, Social and Governance is a widely spread term in both the corporate world and society overall. It is mostly used to describe a style of investing that is environmentally sustainable, socially just, and considers the style in which firms are governed. Institutional investors wishing to align with more environmentally friendly agendas, often place investments in funds with ESG ratings, which rank firms accordingly.

Since 2010, the acronym has become more widely adopted, and despite becoming more visible, to many, it has lost its core meaning due to ambiguity in standards of implementation in ratings and investment. The fact that more than 50 per cent of European funds are labelled as light green or dark green (Financial Times, 2022), is just one example of how this ‘pay to win’ industry works.

ESG evaluation agencies such as MSCI, Sustainalytics and Refinitiv reduce the risks associated with litigation and administration in the future often solely using publicly available data. Not only do these offer a comparison between competing firms, it also offers a sign of intent, in the long run, of adequate corporate social responsibility to shareholders, rather than just a significant competitive advantage in the short run However, the truth is that ESG ratings for individual firms and funds can be inaccurate, and this misleads investors whilst unfairly distorting public opinion surrounding companies and markets. Furthermore, rating systems that exaggerate the overall sustainability of firms,tocreatevarianceinthemarketandencouragemore sales and revenue, can leave firms and investors overconfident and over-satisfied with their operations and portfolio’s true ESG performance. The fact that there is no regulation enforcing the publication of ESG ratings in the UK, means that firms without ratings can fly under the radar, leading to market ratings that are too optimistic regardingESG

According to Andrieux (2022), 60% of consumers are not aware of what exactly ESG ratings and assessments entail and that only 25% of investors choose their portfolio with ESG factors in mind ‘Principled self-interest’ is considered the main motivation behind few who do consider ESG investing as per Mohanan (2002). Furthermore, there are suggestions that labels in regard to ESG being sufficient, are all that is required by the majority of investment managers and clients. This begs the question as to whether investors are aware of the true impact of their investments on the environment and society, and whether superficial social pressure is degrading the importance of environmental sustainability and effective social justice.

The future of ESG as a core aspect of investment management is under threat from lack of uptake, inaccurate and inconsistent ratings, investor apathy and ignorance. The question to ask is what can be done to protect the vital role ESG ratings and CSR plays in keeping corporations and institutions accountable for their choices. One answer to this question could be the wider introduction of financial advisers, which previously have only been available to those investing large sums of money. Research has found that 70% of non-ESG investors have not had a discussion with a financial adviser about sustainable investing while in contrast, 72% of ESG investors have used financial advisory services (Andrieux, 2022 ). Whilst this trend may simply show that those with higher incomes have more freedom to trade off socially and environmentally sustainable investing with inflation-offsetting returns, it could also show that when confronted with the true facts of investing, individuals do actually select portfolios with stronger ESG elements.

References

Gunthrie, J. & Moore, E. (2022) “EU fund managers: ESG funds confused by 50 shades of green”, Financial Times Lex Column, 5/11/22 edition Available at: https://www.ft.com/content/3655eb18-4c54-4472-970fcd571b76f8bc (Accessed: 03/12/22).

Monahan, Michael. (2002) “The Ethics of Socially Responsible Investing.” Business & Professional Ethics Journal, Available at: http://www.jstor.org/stable/27801288. (Accessed 04/12/22).

Andrieux, Jean-Baptiste (2022) “Most investors unaware of ESG, finds report” MoneyMarketing Journal, Available at: https://www moneymarketing co uk/news/most-investorsunaware-of-esg/ (Accessed 03/12/22)

MSCI (2022) “The Evolution of ESG Investing” MSCI Website Available at: https://www msci com/esg-101-what-isesg/evolution-of-esginvesting#:~:text=The%20practice%20of%20ESG%20investing,the %20South%20African%20apartheid%20regime. (Accessed: 03/12/22).