Insight

Can ESG save the world? The Economist says no, we say maybe . . .

By Andrew Wilson,

Director and Head of Responsible Business

There are many in business, the investment community and wider society who recognise that profits alone are not the only measure of economic success. They have been behind the massive growth in assessing business performance against wider Environmental, Social and Governance (ESG) criteria.

Advocates of ESG point to research, such as that undertaken by Arabesque the asset management firm, that shows a strong correlation between diligent sustainability business practices and economic performance. As a result, we have seen huge amounts of capital shift toward green and responsible businesses - a record $350bn (£247.6bn) flowed into ESG funds in 2020.

However, we now have The Economist stepping in to burst this bubble. The leading article in the journal’s latest edition offers a stark appraisal of this key tenet of sustainability. It suggests that “often well-meaning” ESG is “deeply flawed”. In their view, “[ESG] risks setting conflicting goals for firms, fleecing savers and distracting from the vital task of tackling climate change.”

“[ESG] risks setting conflicting goals for firms, fleecing savers and distracting from the vital task of tackling climate change.”

Their solution? ESG should be reduced to one simple measure of carbon emissions.

While ESG assessment, analysis and performance measurement can all be improved, The Economist is offering us very weak gruel by way of an alternative. Removing the focus on Social and Governance elements in favour of an exclusive emphasis on one simple measure of Environmental performance would be a hugely retrograde step.

The Economist seems to suggest that measuring and reporting on ESG performance allows us to fudge tensions between environmental and social issues. Clearly such tensions exist. A company can drastically reduce its carbon emissions by closing a factory and laying off thousands of people. We also know that the manufacturer of electric vehicles in Europe is dependent on the mining of cobalt, used in lithium-ion batteries, in countries that have extremely poor human rights practices.

The fact that ESG cannot adequately ‘square these circles’ and balance competing tensions should not be a reason to abandon our efforts to measure the broader impacts of business. We would argue that ESG is a small but important step in providing a frame of reference for investors, analysts, and others to assess the long-term risks facing a business, and calculating the future value of the decisions taken to address the competing demands it faces.

The approach to assessing corporate performance across ESG criteria helps people to begin to see the systemic nature of the challenges we face. It forces us to recognise that decisions in one area of activity, (or in one country, or at one point in time) will have measurable impacts in other areas / countries / at some point in the future.

Trying to reduce the measurement of responsible business to simple metrics about emissions is fatally flawed. While measuring emissions data is necessary, it is wholly insufficient in tackling the climate and nature crisis facing us all. It is not enough to be a sustainable business (with low carbon emissions) in an unsustainable world. We should be encouraging business to extend their measurement and reporting to encompass their wider impacts.

The Economist is right to point out that ESG is far from perfect. However, this should not be used as an excuse for inaction or a return to narrow measures of business success. We need to be both creative and pragmatic to help companies drive systemic change.

At Lexington we work with businesses to assess and manage their broader responsibilities, across all aspects of ESG, and in so doing we help to ensure their long-term commercial success.