Rather to my surprise, Florida state governors and I agree – over the scrutiny of ESG.
There is a growing sentiment among policymakers and within the business community, that ESG is failing to achieve its original intentions. It has become a tick-box exercise that creates no material change, and is causing companies to lose focus of their original purpose. Unfortunately, this is to some extent true, and to truly create a sustainable business and a better world, ESG needs introspection.
While anti-ESG governors in Florida and Texas are raging a cultural war under the guise of financial risk, there are more pertinent concerns that ESG is at greater risk of being reduced to a tick-box exercise, with companies reporting against metrics without making substantive changes to their responsible business practices.
ESG has evolved from its predecessor, “corporate social responsibility”, or CSR, to include metrics and ratings, turning it into a numbers game and competition to win, with potentially major reputational benefits for corporates that score highly. Despite best efforts to push ESG beyond a tick-box exercise, and investor involvement highlighting the benefits of embracing such practices, it, unfortunately, remains another numbers game. The real risk a company faces is not a low ESG score in the rating tables, but a poor understanding of what ESG means – causing even the most “sustainable” companies to come tumbling down.
The recent economic downturn has been clouded by an increase in anti-ESG narratives, particularly in financial circles, where critics argue even a “good ESG score can’t save you”, or that the overemphasis on ESG has even instigated the economic downtrend. But a closer inspection finds it is not ESG causing the downfall, but a misunderstanding of what ESG looks like within a business.
A collapse of any business can stem from failing governance – the forgotten letter. As the Economist writes, governance is the critical angle. Not the governance that suggests high diversity on the board, as ESG ratings suggest, but the intention and purpose of the business. Governance goes to the heart of what a business is. Quality governance is understanding the cost of your externalities and risk, being part of progress through productive dialogue, and adjusting your business model accordingly. Without quality governance, there is no business.
ESG has become a term in and of itself and has grown beyond the letters it started with. It came out of investors looking for returns beyond just financial, but the meaning has become so diluted and focused on the metrics, that it misses the big picture of what corporate sustainability is.
A business’s main purpose is to create value for shareholders (among others) and that means being profitable; and in recent years, it is those shareholders who are demanding sustainability. Asset manager BlackRock states how shareholders don’t tolerate ESG inaction causing adverse impacts on the business and reputation. With strong governance to understand what shareholders want, both now and in the long term, ESG will follow. ESG is not something achieved through a high score, but is the internal process that creates a good, high-value, profitable business that will last for generations. The consideration of long-term risks to a business includes looking holistically at the world, at climate risk, at social impact, at creating a legacy everyone would be proud to be a part of – which are inherently ESG considerations.
Sustainability and a business’s true value lie beyond numbers or letters – let’s remember there is more to the alphabet than E, S & G.