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Should there be a “C” for credibility in ESG?

The biggest challenge facing concerted action on environmental, social and governance issues – ESG – is no longer the question of whether they are important, it’s how they are implemented.

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No credible economic analysis (leaving aside the moon landing was faked brigade) ignores the threat to ongoing improvement in human prosperity and wellness that comes from global warming, environmental degradation, entrenched discrimination, widening wealth disparity and corruption – to barely touch on the matter.

"As ESG grows in significance, so too does genuine confusion alongside attempts to game the system, whether that be green washing or fudging gender and diversity numbers or failing to measure social impacts with any fidelity."

The bigger challenge is disentangling, measuring and acting on the E, the S and G fronts realistically and without efforts on one measure undermining another.

For example, The Economist newspaper argued “Elon Musk of Tesla is a corporate-governance nightmare, but by popularising electric cars he is helping tackle climate change.”

As ESG grows in significance, so too does genuine confusion alongside attempts to game the system, whether that be green washing or fudging gender and diversity numbers or failing to measure social impacts with any fidelity.

Indeed, a recent edition of The Economist – which editorially would probably be categorised as left wing in parts of Australia and America – asked whether ESG should simply be dismantled.

“It is deeply flawed,” the newspaper opined in a special edition. “It risks setting conflicting goals for firms, fleecing savers and distracting from the vital task of tackling climate change. It is an unholy mess that needs to be ruthlessly streamlined.”

The Economist’s key allegations are that ESG is confusing, internally inconsistent, lacking in external consensus and too easy for the right wing reactionaries and rent seekers to pick apart. The paper proposes dumping both S and G and focussing on E – primarily with a price on carbon.

A proper debate is necessary. As with the justice system, if a decision is to be respected, the accused must be given the best possible defence and opportunity to test the allegations.

It is critical for those who understand the value in the broad agenda of ESG to be able to prosecute their case in a detailed and comprehensible manner with suitable evidence. Otherwise detractors, deniers and those with vested interests will sow discord. As they are doing.

Even now, opposition to ESG is taking concrete form in the more conservative states of the US. For example, in Idaho, legislation has been passed prohibiting the state’s investment funds from considering ESG characteristics “in a manner that could override the prudent investor rule”.

It doesn’t matter that reason and evidence amply demonstrate considering the impact of the environment, society and governance on investment returns is prudent.

This is a crucial debate – which is why it is welcome those who broadly support it continue to debate it.

The Financial Times, for example, The Economist’s only real rival in economic credibility in the English language, took a broader line.

The FT’s governance editor, Simon Temple-West, writing in the journal’s Moral Money newsletter, noted “it would be short-sighted to ignore ESG’s influence in wringing diversity disclosures and driving pressure for workplace rights - crucial social concerns that have progressed rapidly in the past 18 months.

“As The Economist and others have pointed out, government action is vital to tackle problems like global warming. But in the absence of comprehensive reforms, ESG is clearly having some impact.”

Clearly though, imprecision in detail, data and diagnostics clouds transparency and makes meaningful comparisons difficult in this domain. One of The Economist’s telling points was this: “various scoring systems have gaping inconsistencies and are easily gamed. Credit ratings have a 99 per cent correlation across rating agencies. By contrast, ESG ratings tally little more than half the time.”

These issues, as widespread and profound as they are, don’t of course mean the impetus in improving environmental, social and governance outcomes should be abandoned. Rather, there needs to be more clarity, consistency and comparison.

Progress is continuing.

The Australian Banking Association, for example, has just achieved a consensus on the need for sustainability reporting, including action on climate risk. The consensus includes Australia’s most influential business and finance bodies, including Chartered Accountants Australia, the Australian Shareholders Association and the Australian Council of Superannuation Investors, representing more than 400 enterprises, 300 investors with US$33 trillion assets under management) and 500,000 business and finance professionals.

The new reporting regime aims to consider clear, transparent, comprehensive and comparable disclosure of sustainability-related information to be part of the foundation of a well-functioning global financial system and “supports a global approach to the development of sustainability disclosure standards”.

“The overarching goal should be a globally consistent, comparable, reliable, and verifiable corporate reporting system to provide all stakeholders with a clear and accurate picture of an organisation’s ability to create sustainable value over time,” the ABA said.

“It is critical that the ISSB (International Sustainability Standards Board) and other jurisdictions developing sustainability standards take a coordinated approach to avoid regulatory and standard setting fragmentation by aligning key definitions, concepts, terminologies, and metrics on which disclosure requirements are built.

Even without the desired clarity and consistency, providers of capital are moving ahead on the expectation consensus will emerge because the issues of ESG, and notably climate change, are becoming more pronounced.

ANZ’s head of sustainable finance, international, Stella Saris Chow, told a recent forum there has been a shift based on policymaking towards tackling climate issues in South East Asia.

“I expect to see further growth in both sustainability-linked bonds (SLBs) and sustainability-linked loans (SLLs), moving away from the traditional use of proceeds. It will also be interesting to see how the market for transition bonds develops,” she said.

The Economist noted the “titans of investment management claim that more than a third of their assets, or $US35 trillion in total, are monitored through one ESG lens or another.” McKinsey & Co argue achieving net-zero carbon emissions by 2050 “may well prove to be the largest reallocation of capital in history, an increase of spending between $US1 trillion and $US3.5 trillion a year.”

Meanwhile, action from governments, regulators and supervisors continues to push towards ESG and climate change risk management and investment. Here too greater coordination is emerging.

Pablo Hernández de Cos, Chair of the Basel Committee on Banking Supervision and Governor of the Bank of Spain, noted a number of key questions need to be answered.

“These include: (i) what definitions are needed to build comparable disclosures, and whether a common taxonomy of activities at a global level is feasible; (ii) whether and how we can develop a common sector classification that identifies the relative transition and physical risks of different industries; and (iii) how best do we balance the disclosure of qualitative and quantitative information. These are questions that require ongoing analysis and discussions at the global level.”

Without this great clarity and consistency, the complexity and internal inconsistencies of ESG are vulnerable to all those issues The Economist outlined. The need for action may be clearly evident but how to measure it isn’t.

Andrew Cornell is Managing Editor of bluenotes

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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