Environmental, social, and governance
[1] The term ESG first came to prominence in a 2004 report titled "Who Cares Wins", which was a joint initiative of financial institutions at the invitation of the United Nations (UN).
As a response to a growing call for sanctions against the regime, the Reverend Leon Sullivan, a board member of General Motors in the United States, drew up a Code of Conduct in 1977 for practising business with South Africa.
The resulting pressure applied to the South African regime by its business community added great weight to the growing impetus for the system of apartheid to be abandoned.
[11] His contention that the valuation of a company or asset should be predicated almost exclusively on the financial bottom line (with the costs incurred by social responsibility being deemed non-essential) was prevalent for most of the 20th century (see Friedman doctrine).
In the City of London in 2002, Chris Yates-Smith, a member of the international panel chosen to oversee the technical construction, accreditation, and distribution of the Organic Production Standard and founder of a branding consultancy, established one of the first environmental finance research groups.
Philanthropy was not considered to aid profitable business, and Friedman had provided a widely accepted academic basis for the argument that the costs of behaving in an ethically responsible manner would outweigh the benefits.
[14] In 2011, Alex Edmans, a finance professor at Wharton, published a paper in the Journal of Financial Economics showing that the "100 Best Companies to Work For" outperformed their peers in terms of stock returns by 2–3% a year over 1984–2009, and delivered earnings that systematically exceeded analyst expectations.
[22][23] In addition, surveys of ultimate beneficiaries (on whose behalf savings and pensions are made) typically show high levels of support for considering social and environmental issues alongside long-run, risk-adjusted returns.
[25] In January 2016, the PRI, UNEP FI and The Generation Foundation launched a three-year project to end the debate on whether fiduciary duty is a legitimate barrier to the integration of environmental, social, and governance issues in investment practice and decision-making.
The results of various surveys seem to confirm these disparities, showing a more favorable trend in Europe, the Middle East, Africa (EMEA), and, Asia-Pacific, in contrast to North America.
[56] As with all areas of ESG, the breadth of possible concerns is vast (e.g. greenhouse gas emissions, biodiversity, waste management, water management) but some of the chief areas are listed below:[57] The body of research providing data of global trends in climate change has led some investors—pension funds, holders of insurance reserves—to begin to screen investments in terms of their effect on the perceived factors of climate change.
[58] In the UK, investment policies were particularly affected by the conclusions of the Stern Review in 2006, a report commissioned by the British government to provide an economic analysis of the issues associated with climate change.
Hermann J. Stern differentiates four methods to include ESG performance in employee compensation:[72] The growing integration of environmental, social, and governance criteria into investment decisions has spawned a series of myths and preconceptions surrounding their true effectiveness and relevance.
[77] The Environmental (E) pillar of ESG assesses how an industry affects the environment by considering elements such as carbon footprint, pollution levels, resource management, dependence on fossil fuels, and efforts to address climate change.
[21] Where a Pension Fund is subject to ERISA, there are legal limitations on the extent to which investment decisions can be based on factors other than maximizing plan participants' economic returns.
[99] Based on the belief that addressing ESG issues will protect and enhance portfolio returns, responsible investment is rapidly becoming a mainstream concern within the institutional industry.
[110] Equator Principles Financial Institutions (EPFIs) commit to not provide loans to projects where the borrower will not or is unable to comply with their respective social and environmental policies and procedures.
The Equator Principles, formally launched in Washington DC on 4 June 2003, were based on existing environmental and social policy frameworks established by the International Finance Corporation.
[115] Another study points in the same direction, claiming that publishing sustainability reports improves financial performance,[116] and reputation, and it leads to the creation of a significant competitive advantage for the company.
Quantitative models and established ESG ratings do not always adequately capture these values, making it difficult to integrate them into investment decisions based on short-term financial data.
Subsequent studies, such as those by Cochran and Wood in 1984, Aupperle, Carroll and Hatfield in 1985, and Blackburn, Doran and Shrader in 1994, confirmed this lack of correlation between ESG and corporate financial performance, despite differing methodological approaches.
[125] In this highly concentrated ecosystem, small groups of big index providers, like MSCI, play a pivotal role in setting the standards for what is generally accepted as sustainable finance.
Indeed, a company with a higher score doesn’t necessarily mean that it has strong environmental, social and governance effect on the world, but rather a low exposure to ESG risks.
One of the major aspects of the ESG side of the insurance market which leads to this tendency to proliferation is the essentially subjective nature of the information on which investment selection can be made.
A lack of clear standards and transparent monitoring has led to fears that ESG avowals mainly serve purposes of greenwashing and other company public relations objectives, while distracting from more substantive initiatives to improve environment and society.
[150][151][152] In remarks made by video conference to the European Parliament Committee on Economic and Monetary Affairs in September 2021, SEC Chair Gary Gensler stated that the agency was preparing recommendations for new disclosure requirements for ESG investment funds.
[191][192] In March 2022, Deutsche Bank agreed to extend the term of an external compliance monitor until February 2023 from its 2015 settlement with the Justice Department to address its failure to disclose the internal ESG complaint from its former chief sustainability officer the previous August.
These challenges call for reforms aimed at normalizing, standardizing, and making more transparent ESG criteria and disclosures to enable more accurate assessment and better decision-making for investors committed to sustainable and socially responsible practices.
[208] Another major challenge facing ESG-driven investments lies in the apparent conflict between the short-term imperatives of financial markets and the often visible longer-term benefits of ESG initiatives.
Companies have considerable leeway in choosing which criteria to disclose, leading to heterogeneity in reporting and making it difficult to compare the ESG performance of different entities.
