Gobbledegook, Good Times and Doing Good
Gobbledegook, Good Times and Doing Good
The Past, Present & Future of ESG
It is hard to think of a three-letter term that plays to global ambitions more than ESG in today's corporate world.
“I think it's a great evolution. Some people would say even a revolution.”
- Klaus Schwab (2021)
“I am increasingly convinced that corporate ESG is the Devil Incarnate.”
- Elon Musk (2022)
Today, 95 percent of S&P 500 companies issue a sustainability report. Can you even be a serious company today without an ESG report? A company without an ESG report would be like an emperor with no clothes - or is it the other way around? In our world of Chat GPT verbiage, it can be hard to distinguish what is real and what is conjured algorithmically from thin air with a few interspersed datasets.
As the world gathered for Climate Week in New York this month – the letters E, S & G gave the standard-bearers of the S&P another run for their money. But is it sustainable?
This is a story of gobbledygook, good times, and doing good. This is a story about the origins of ESG, its rise, and, like many good things that get coopted, exploited, and converted into tools of grift – its ultimate decline.
Corporations Leading the Call
On the surface, ESG sounds like a clear clarion call, coalescing around three conceptual pillars: environmental, social, and governance.
Corporations have valiantly responded to the call, as illustrated below:
“Our vision for a safer, more connected world – one where inclusion is paramount, where we collectively respect sustainability, and where we all operate with integrity and respect – continues to guide us. We honor the global responsibilities inherent to our industry by helping people and the environment and by embodying our core principles. In practice, our Environmental, Social, and Governance (ESG) strategy is inextricably linked to business strategy, helping drive momentum toward our goals…
While we continue to focus on building technology solutions for a better world, we are grounded by the fact that none of it is possible without a vibrant workforce. To that end, we put significant focus into developing and advancing the people who drive these innovations. We continued our commitment to diversity, equity and inclusion (DE&I) outcomes, as well as invested significantly in building a strong future pipeline of talent and continue to reinforce that lifelong learning is essential to individual growth and opportunity. We have a clear line of sight into the enormous challenges of the day – from climate change to economic uncertainty to global conflict. I am confident that together we can indeed create a safer, more connected world, and protect it for generations to come.”
This fulsome prose was penned by Gregory Hayes in his role as the Chairman and CEO of RTX, arguably the largest weapons manufacturer in the world – weapons that are diverse, inclusive, and equitable.
ESG is a framework that has as its north star positive change. While that is at its core, the question must be asked – is ESG a myth and a mirage?
A Rise to Riches
It is hard to overstate the convergence of ESG with today’s financialized economy. In a chase of never-ending returns and to differentiate beyond everyday ROI to retail investors, ESG has emerged as a valued metric. It is no wonder that ETFs, mutual funds, and other index funds have been the most significant adopters. If a fund is not ESG-centric, at the bare minimum, it is ESG-adjacent.
Late last year, PWC assessed that “ESG-focused investment” would reach nearly $34 trillion and represent a fifth of all assets under management (AUM) worldwide. Bloomberg determined that ESG assets had already surpassed $35 trillion and would reach $50 trillion by 2025. Morningstar uses a more direct metric to mark global sustainable fund assets at $2.8 trillion. With Vanguard, State Street, and Blackrock – as three of the largest asset managers in the world – placing an increased emphasis on ESG, it has become almost impossible for a company not to have some ESG centrality in its reporting.
The S&P 500 ESG Index weights companies by their ESG scores. In 2022, this index outperformed the regular S&P 500. That is not without controversy, as Tesla’s ESG score (37) was lower than Shell’s (41) in 2022. However, after the bumper year of 2021 and a further echoing of the trend in 2022, 2023 has seen backsliding in the overall confidence in ESG.
This summer, even CNN published an article titled, “The responsible investing boom is over. Can anything replace ESG?” The Economist featured a story in this year's June issue titled “A Broken System Needs Urgent Repairs.” It read, “The environmental, social, and governance (ESG) approach to investment is broken. It needs to be streamlined and stripped of sanctimoniousness.” This is from within the mainstream.
Indeed, some of the noise leading to the criticism has been driven by partisan politics in the United States, where governors of two of the largest economies in the country, Florida and Texas, explicitly cut ties with any asset manager that was emphasizing ESG (this notably affected Blackrock). Nevertheless, broad trend lines show that the next current thing is already fading from the spotlight. That is evident from a cursory look at Google Trends.
Before we unpack this further, it’s important to understand the movement's origins.
The Origin Story
Before ESG, there was CSR. CSR emerged first from the mind of American academic Howard Bowen, who covered the concept in his 1955 book, Social Responsibilities of the Businessman. Yet, consumer activist Ralph Nader carried the torch to put corporate America’s feet to the fire. His prolific protests against the American automotive sector, at that point the engine of global capitalism (literally and figuratively), resulted in landmark changes in both regulation and perceptions of corporate responsibility.
Around the same time, growing awareness of aspects of environmental degradation, notably urban pollution and pesticides, led to the creation of the Environmental Protection Agency and the Clean Air Act in 1970. The 1970s were the decade when organizations emerged aplenty, raising alarm about humanity’s impact on the planet. From Greenpeace to the Environmental Defense Fund, a broad base of activists put the world on notice.
At the end of the Cold War, there was a further recognition of a globalized world under one operating system. Within that system, corporations were rising to have power equivalent to that of some countries (albeit not to the level of America). There were fundamental questions about how powerful multinational corporations were and whether this posed an existential danger.
The 1990s opened the floodgates to an anti-capitalist march, and corporations were enemy number one. The anti-WTO, anti-IMF, and anti-APEC protests all confronted a neo-liberal order where corporations were allegedly running amuck. And amuck some were. Whether it was Nike and its sweatshops or Monsanto’s shenanigans in Latin America, cases were numerous of corporate malfeasance. And then there was the propagation of corruption abroad. In the United States, foreign corruption was only made illegal in 1977. In many European countries, this came much later.
It was evident in an American globalized world, without global checks and balances, multinational corporations were not being held accountable. At Davos in January 1999, around the same time that the Millennium Development Goals (MDGs) were being formulated, Kofi Annan proposed a new “global compact on human rights, labor, [and the] environment.” In his remarks to corporate leaders, he continued, “You can uphold human rights and decent labor and environmental standards directly, by your own conduct of your own business.”
The UN Global Compact was launched to much fanfare in 2000. Similar to the MDGs, only a little happened for almost five years. In a landmark report, Who Cares Wins, prepared by the Global Compact in 2004 for a summit to be held the following year, the environmental, social, and governance (ESG) tripartite frame was laid down. There was no lack of clarity about the intention, with the report stating up front:
“We are convinced that it is in the interest of investors, asset managers, and securities brokerage houses alike to improve the integration of ESG factors in financial analysis. This will contribute to better investment markets as well as to the sustainable development of the planet.”
In many ways, the report is detailed and unambiguous about the scope ESG has reached today. Who says the UN doesn’t have an impact and is irrelevant? In some estimates, it mobilized one-fifth of global assets under management to align at least on paper to a common agenda!
The challenge, of course, with the report was implementation. The Principles for Responsible Investment became a platform to onboard asset managers to commit to adopting ESG principles. It helps that the UN is based in New York, the world's financial capital. The chart below shows that asset managers with AUM north of $120 trillion have signed up.
Made to Measure
A movement was afoot, but measurement was far behind and muddled with competing frameworks. Prior to the efforts by the United Nations, the Global Reporting Initiative (GRI) had been set up independently and had a set of reporting standards across a range of indicators. Before ESG’s emergence, several organizations had also begun to enact measurements around socially responsible investing (SRI). In 1999, the Dow Jones Sustainability Indices were deploying specific measurements. When the SDG Agenda was launched in 2015, it only added more confusion about the North Star, with 17 goals and almost 250 indicators (and growing?).
Today, knowing where to turn for the optimal ESG measurement is challenging. Do you adhere to the S&P’s standards? What about MSCI? IFRS announced the development of a new International Sustainability Standards Board in 2021. Those standards are now set and perhaps offer a mega-solution to the so-called alphabet soup of reporting and fold them into mandated financial reporting standards globally.
Yet, an overarching standard seems difficult to achieve in an already muddled landscape. The European Union has its standards coming on board in January 2024. Different requirements are also emerging in the UK and being discussed by the SEC. Industry-specific standards also remain. Finally, certain countries and companies may seek to emphasize a particular sliver of the ESG agenda, such as climate emissions, for instance, or equitable pay. Can the standards be standardized, or will they always be made to measure?
The Great Grift
This brings us back to where we are in the stage of the process:
‘Many good things get coopted, exploited, and converted into tools of grift.’
ESG started in a good place, was co-opted by global corporate interests, exploited to advance certain narratives and the weight of larger players, and, let’s be honest, has become a multi-billion dollar grift that has become so diluted as to lose most meaning. We are indeed nearing the end of the rise. The emperor has no clothes and will soon be faced with a mirror.
It will not be so easy, however, to unwind. This is a half-century of efforts culminating in the sailing of an ESG titanic of all-consuming standards that will surely hit an iceberg of slow collapse. This does not mean that notions of stakeholder management or sustainability will fall by the wayside. Yet, in a time of raised interest rates, an all-consuming metric that fails to be clearly defined nor has a clear profitability inherency does not have a long horizon.
Politically, ESG has become a contested issue and is being challenged. The problem is that to achieve universal standards, politicizing their perception and specific components undermines the effort. It also leads to bias and score-settling. Ultimately, the private sector and business more broadly seek to be apolitical on a day-to-day basis.
Scaling in a market like the United States would be impossible for a consumer goods company or investment manager if it is to exclude half the states that are ‘right-leaning.’ Yet, the challenge is even more acute globally. Specific social metrics relate to narrow cultural debates within urban America. Is it practical to project this onto Indian, Turkish, and Saudi corporations representing the future of G20 economic growth? Today, ESG goes beyond what is even contained in the broad set of SDGs to serve an evolving and expanding collection of narrow political interests, which are constantly being redefined, and it is unclear even by whom.
Functionally, there is increasing recognition that ESG has become its own industry. Corporations are manipulating the ratings to raise capital in the same way that the mortgage industry manipulated Moody’s and the like ahead of the global financial crisis. Additionally, estimates are that the global ESG and sustainability consulting market will reach $40 billion in 2023. Is that accurate? Feel free to read the report yourself.
Only time will tell how quickly and steep the decline will be. Yes, mentions of ESG have decreased by almost 25% in S&P reports this year, but the standards coming into effect by the SEC and the EU will temporarily lift the sector. Once the regulatory machine starts, the reporting cycle will have no choice but to follow. Yet, it is one thing to adhere to regulatory compliance and quite another to lead with laudatory ESG reporting for market plaudits. The latter will likely go out of fashion like Yeezy sneakers at a Kardashian reunion.
Everything happens gradually and then suddenly. The frothiness of past years will give way to economic frostiness, and it’s in that environment when luxury goods for conference debates will give way to cold economic and business realities.
Doing Good Beyond Good Times
So, where does that leave companies that seek to make a difference? It may be time to go back to clear principles rather than amorphous datasets that can be manipulated.
1. Don’t be evil – This was Google’s adage that it has since removed. It means nothing and everything at the same time. Yet this pithy statement will always push clear debate on who to work with and what to work on.
2. Minimize harm – Following a clear set of policies can ensure harm is minimized to the environment, employees, and all relevant stakeholders. This should always be a clear operating principle.
3. Do good where you can – During business operations, low-cost adjustments can mean doing good can occur as a matter of natural course, whether it is hiring local workers in remote communities, for example, or enabling subsidized access to goods and services in low-income areas where you operate.
4. Maximize profits – Companies that do not maximize profits and have that as an explicit goal will fail to survive and definitely will not thrive. Profits are good, greed is not. This rule does not take precedence over the prior three but follows them.
5. Reinvest your wealth – In the good years, corporations should reinvest their returns in their own innovation, employees, ecosystems, communities, and the world.
If a company decides from a mission standpoint to have an overarching goal, such as reducing emissions, then there can be a hyper-concentration on that. ESG frameworks dilute that focus and may result in corporations focusing on random goals, such as improving the biodiversity of the local butterfly population rather than their own clear mission (note: be pro-butterfly).
Today, much of the ESG data is made up anyway, means very little, and results in beautiful indices populated into pretty PowerPoints that, millennia from now, would appear to be drawn by primitive cavemen, lost in playful superstition.
Be better.