The Quest for “Good” – 5 Dilemmas of ESG and Impact
In the last few years, propelled by the climate emergency and the heightened consciousness or quasi-revelation around inequality and the need for greater inclusion, public equity markets have joined the impact revolution. The term impact, which generally refers to the deliberate and intentional planning, measurement and management of effects or consequences of capital allocations on people and planet, both positive and negative, has been spreading from the aid, philanthropy and private markets to public markets.
But transitioning an entire economic system, primarily motivated by profit (i.e. capitalism), and powered by outdated economic models dating back to the industrial revolution (read Raworth’s Doughnut Economics), with accounting systems measuring a single bottom line (see HBS’ Impact-weighted Accounts), is no small task. Certainly not a task that can be captured in a nebulous, half-regulated, complex and ever-changing set of metrics falling under the ubiquitous acronym of ESG which is, to boot, detached from any global goals.
‘ESG-washing’, ‘greenwashing’ or ‘impact-washing’ critiques are many and their main arguments also tend to be conflicting and somewhat esoteric - quite literally if one reads the paradoxically highly publicised ‘secret’ diary of a sustainable investor. And so, a new dialectic discussion has emerged around what ESG and impact means in the context of public equity markets, centred around the following five synthesised dilemmas.
- Purpose clarity. Are the new financial products branded as ‘ESG, sustainable or impact’ aiming to do good or simply measure what is material to shareholders? In other words, how do these companies or funds impact the planet and people and not just measure the risk or threat posed by the planet and people to their bottom line? In this context, is it ‘right’ to just report on CO2 or GHG emissions or should we aim to decarbonise and/or impose a carbon tax?
- Market size significance. Is the ‘good’ segment of products too small to matter or is it in fact too small to ignore? In other words, is real impact in the public markets even possible with a nascent ESG total market estimated at 2.7 Tn to 35 Tn – across a wider 360 Tn global wealth market?
- Engagement conundrum: is divesting from companies the best option to move the system forward, or engagement a better strategy to influence corporations to be more aligned with a purpose? For instance, is it not surprising that Russia’s oil and gas companies are being divested from now, as if fossil-fuel concerns, corruption, and human rights record, were not embedded in ESG metrics prior to the situation in Ukraine?
- Labelling challenges: Can Exchange-Traded Funds (ETFs) labelled as ‘ESG ETFs’ or ‘Impact ETFs’ be trusted when some of the holding companies may be engaging in activities that are detrimental to the planet (e.g. large CO2 emissions) or people (e.g. unethical supply chains)? Furthermore, can ratings on these funds add any value if subjective à la carte metrics are used to provide ‘AAA’ ratings to companies potentially perpetuating the status quo?
- Data validity. Can the current lack of standardisation, state of voluntary disclosures, based on evolving and multiple regulation regimes, which include ISSB-IFRS, GRI, the World Economic Forum’s Stakeholder Capitalism Metrics, TCFD’s Climate Metrics, possibly lead to meaningful and comparable data? In practice, this means that the notion of materiality itself is evolving and debated, in an ever-changing state of knowledge and actionable awareness (e.g. harm done by methane vs. CO2).
Many of these criticisms or reservations have been brilliantly refuted as they are not dissimilar to some of the issues that have emerged with the onset of the impact revolution in other asset classes: lack of standardisation, questionable relevance of indicators selected and credibility of data, need for verification, and the possible gaps between claims and actual impact. As such, the impact transition in the public equity markets is also very much a work in progress, as it is in the private markets, and the aid and philanthropy world.
The quest for ‘good’ requires a long-term horizon, and a moral compass that is continually sense-checked and closely attuned to the reality of our ever-changing world.
As with all investing, your capital is at risk.
GOODFOLIO Ltd is an appointed representative of RiskSave Technologies Ltd which is authorised and regulated by the Financial Conduct Authority (FRN: 775330).