ESG backlash: in search of credibility and impact

Written by Joesph Payne and Layalee Ramahi

Over the past couple of months, environmental, social and governance (ESG) discourse has been a flashpoint across headlines, from crackdown on investor ESG claims, virtue signalling and corporate greenwashing, all the way to “anti-woke” efforts to block inclusion of sustainability considerations in investment decisions. However, the bottom line is still the same: we have crossed the tipping point for the private sector sustainability journey, where ESG is increasingly no longer just a box-ticking exercise, but more and more requires meaningful and implementable commitments, self-reflection over business models, accountability to stakeholders, and transparent transition plans and progress reporting.

Indeed, while we have seen governments and the private sector step up their commitments, in particular around climate change, we are falling short in terms of real action, emission reductions and progress on sustainable development. So, while 91% of global GDP and 83% of emissions are now covered by net-zero commitments, government policies are off track to limit global temperatures to below 2°C, and corporate climate strategies remain mired by “loopholes” and “ambiguity”. The UN’s latest update on progress towards the SDGs, calls for an urgent rescue effort to achieve the 2030 Agenda and support the world’s most vulnerable people.

This urgency sets the context for scrutiny at the corporate level, with regulators and consumers increasingly alert to greenwashing in all its forms, and shareholder activist groups taking boards to task over flawed climate and energy transition strategies.

We have little time and carbon budget to spare, to meet the Paris Agreement and the Sustainable Development Goals (SDGs). From regulators demanding more clarity from investors, to stakeholders calling for clear transition plans from companies, scrutiny, accountability and, indeed, backlash for those whose words are not borne out by action, should be seen as a sign of necessary progress that will distinguish the leaders from the laggards.

ESG is here to stay

An important footnote to the noise of the debate around ESG effectiveness, greenwashing claims and the politicisation of the conversation is that, in the end, the urgency of managing sustainability impacts, risks and opportunities, whether by the public or private sector, is here to stay.

From climate change to human rights abuses in the supply chain, there is sufficient research and quantitative data to empirically validate that ESG performance is correlated with financial performance. Investors and business leaders alike have started to acknowledge the risks and opportunities impacting their bottom line and profitability. It is imperative for businesses to identify those critical issues and have a strategic approach to mitigate risk and minimise impact. Despite 2022 proving to be another economically turbulent year, in the midst of war, recession fears, skyrocketing inflation, natural disasters and economies barely recovering from the pandemic, demand for sustainable investments remained positive, assets under management (AUM) totalled nearly $2.8 trillion, an increase in its proportion of overall AUM to 7% from 4% five years ago. On the policy side, the energy transition is only gathering pace, with renewable generation capacity additions hitting record levels (wind and solar generation passed natural gas in Europe – having passed coal in 2018), and US congress beginning to roll out a historic funding package that will support clean energy transition and climate resilience.

Our understanding of the dynamics between environmental and social issues and business performance, and the data and methodologies for monitoring and demonstrating outcomes, is also rapidly maturing. We are gradually breaking out of silos, not only between the E, S & G, but within companies, across sectors, regulators, stakeholders and governments. And we’ve seen a boom in standards and initiatives seeking to put order around these interconnected issues.

However, this landscape is still evolving and settling around what works. Something that can be overwhelming for businesses and analysts, as well as creating wiggle room for inconsistent actions, decisions, and communications. Companies find themselves in different places. Some are “opportunists”, seeking to capitalise on the market opportunity and demand for sustainable products and services, interested more in riding a wave of marketing claims than in backing this up with concrete actions or strategies. Others are “aspirational” companies, early in their journey and likely struggling to digest and align with the proliferation of standards, good practice expectations and regulations, making meaningful forward progress slow. And lastly, there are those companies who are vocally “committed”, have internal buy-in to improve their sustainability performance, and are gradually making progress.

When it comes to greenwashing, clearly the first group stands out as lead culprits, and where they are allowed to avoid consequences of cutting corners, this undermines and deters other companies from really committing to and investing in sustainability. But as recent cases have shown, the risk of insincere, misaligned or inflated claims is real for all companies. Because as we move from box-ticking to a focus on impact, outcomes and planetary limits, making a commitment and setting long-term targets is only the start. Take the example of HSBC, which was slammed by the UK advertising watchdog for a series of misleading ads that cherry-picked the bank’s climate-friendly initiatives, yet failed to acknowledge its own contribution to emissions through its financing, or set out a clear plan for transitioning its business model to one that’s consistent with a zero-carbon economy.

Navigating ESG turbulence

Navigating this turbulent time and scrutiny of ESG, requires a two-pronged, top-down and bottom-up approach.

Starting off with the enabling environment, governments and policymakers need to uphold their sustainable development commitments and Nationally Determined Contributions, rise to the moment, and up their ambition with policies and regulations that give clear signals and incentivise the transition. This should be combined with a robust, harmonised framework of supporting standards and guidelines that define good behaviour in a consistent way, and enable company performance to be measured and differentiated. Similarly, citizens, civil society and investors must maintain pressure on the public and private sectors, calling out inconsistency and nudging the goalposts to where they need to be.

As for the private sector, investors and corporates alike must be realistic and transparent with themselves and their stakeholders about their sustainability ambitions and impacts, and ensure that their strategy is consistent across the business, their investments and their value chain. So, breaking it all down: what should your company be doing?

1. Make the Board and C-suite part of the conversation, not just an audience. Setting up the right oversight and governance structure is key for driving the actions and investments that will be needed to embed sustainability in the business model.
2. Data is gold, but showing impact is diamond. Most companies will already report a range of “output” style metrics that capture the scale of their activities in relation to different ESG issues. A step towards demonstrating sustainability, is to capture the positive or negative impacts and outcomes of those activities for stakeholders and ecosystems. What are we really interested in: the kilograms of local air pollution, or the health outcomes for neighbouring communities?
3. Show your workings. Collecting and managing data is a foundational element. If greenwashing risk is to be minimised, performance indicators, targets and strategies must be consistent and verifiable: would a reasonable outsider review your workings and feel that associated claims are justified?
4. A credible climate commitment and transition plan needs to be honest and forward looking about investment. The UN estimates that transitioning to net-zero, climate-resilient economies by 2050 will require the mobilisation of US$3-6 trillion each year. How is your company planning its transition investments to manage emerging risks, cut costs and capture opportunities?
5. Leverage voluntary reporting frameworks, but understand that a perfect “ESG score” gets you only so far. The age of box-ticking is over. Companies that are only targeting short-term advances on ESG questionnaires without a clear understanding of impact and transition planning, are at risk of emerging regulation and greenwashing.