Insights: The evolution of ESG - From good actions to metrics
By Sandra Herrera - Companies of all sizes are including ESG considerations within their strategic decisions. While for some this is not new, each are challenged by novel measuring and accountability requirements. These include determining the impact of these considerations while assuring that matters previously ignored, are now included.
Many drivers are boosting this development. Consumers prefer brands that have a purpose, 7 out of 10 employees want their jobs to have societal impact, regulators are amplifying their long existing governance requirements to request reports on social and environmental issues, groups of companies with shared interests have gathered to make statements on voluntary agreements on ESG and impact investors are now considering ESG factors when deciding where to allocate their funds.
Stakeholders are increasingly using metrics for decision-making. Investors and finance professionals routinely utilize statistics, indicators, and other economic data to generate risk profiles that can forecast with relative accuracy the future health of the company.
But is it possible to create indicators on ESG to foresee the risk of disregarding the actions to prevent climate change? Can we create metrics to show the cost if a company does not advocate for social justice? Can we develop rigorous non-financial standards with the same quality as existent accounting standards? Can companies with assess their climate-related risks with an acceptable degree of certainty?
There are a number of third parties providing ESG ratings and rankings based upon proprietary methodologies addressing these questions. The result is a confusing array of thousands of ESG scores, making it difficult for investors to truly understand the meaningfulness of this data. ESG rating standardization is arriving slowly, mostly spurred by governmental initiatives rather than market forces. Regardless of the impetus, the key for accepting any of these scoring systems will be the degree of methodology transparency. Once more standardization arrives, the usefulness of ESG metrics on corporate decision making will increase.
Despite these assessment limitations, impact investing has proved to attract asset owners eager to make profits while also "doing good." ESG based investment fund growth continues unabated and is projected to soon represent 21.5% of the total global assets under management. These ESG funds have at least equaled, and sometimes exceeded the financial performance of non-ESG based investments.
For this investing trend to be sustainable, funds with purpose need to continue to provide the same monetary returns than other types of investing. This will increase the attractiveness of ESG based investments to the entire investment market with a concomitant constructive impact on ESG concerns. Funds that do not have equal return as other types of investments will only be able to survive if they can demonstrate through broadly acceptable ESG metrics that the sacrifice of financial returns is worth the positive impact on these important environmental and societal issues. The challenge now for asset managers, regulators, ratings providers and the rest of the entire ESG ecosystem is to develop metrics that can effectively predict and demonstrate a company's performance in the topics stakeholders consider important.
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