Is ESG Over? Exploring the Future of Sustainable Investing
Highlights
BlackRock’s CEO announced in summer 2023 that they would no longer use “ESG” to describe their investment strategies. Big changes ahead?
ESG has evolved from corporate social responsibility and socially responsible investing to include all sorts of things that influence corporate behaviour and profitability.
The ESG conversation is moving towards materiality, where we need clear, measurable standards for environmental and social factors.
Companies need to integrate measurable environmental and social factors into their business strategies to stay competitive and responsive to stakeholder demands.
In the summer of 2023, a big change happened in the business world when Larry Fink, CEO of BlackRock (who manages over $9 trillion) announced they would no longer use “ESG” to describe their investment strategy.
This came as ESG has been growing in popularity over the past 20 years and has faced backlash in the US against “woke” investing.
BlackRock is often seen as a trendsetter in business because of their size and Fink’s loud voice. So the question is: has ESG reached its peak? Have we hit “peak ESG”?
Aaron K. Chatterji, associate professor at Duke University, and Michael W. Toffel, the Senator John Heinz Professor of Environmental Management at Harvard Business School, have been studying the intersection of business and society for years. They know that many of the ESG issues we see today were once discussed under the headings of corporate social responsibility (CSR) and socially responsible investing (SRI).
The origins of the ESG movement go back to the demand for corporate accountability. Investors (pension funds and institutions) wanted to avoid companies that were imposing costs on society through pollution or harmful products or to influence companies to adopt more responsible practices through shareholder proposals.
On the supply side, companies started to measure and improve ESG factors like carbon emissions, product safety and governance. Financial intermediaries emerged to bridge the gap between demand and supply by offering ESG ratings and due diligence.
Societal pressure on businesses to follow social norms has been around for a long time, but the ESG movement really took off in the early 2000s with the 2004 UN report “Who Cares Wins”. That report said that managing ESG factors relevant to business competitiveness and reputation would improve financial performance.
But the logic of combining environmental, social and governance factors has never been clear, and as ESG entered the mainstream, it got complicated. The past 20 years also saw the rise of impact investing, where funds aim to finance socially beneficial projects and sometimes accept lower returns. The lines between impact investing and ESG got blurred, and many MBA students expect ethical practices to align with profit maximisation.
Today, the ESG conversation is moving towards materiality, as seen in the recent US SEC rule that requires companies to disclose how climate change affects their financial forecasts. The new concept of “double materiality” takes this further by including not only financial implications but also the broader societal impacts of corporate actions.
This mixing of financial and social considerations makes ESG complicated and vulnerable to criticism. The term ESG has become so broad that it includes strategies that do not always align with financial goals. ESG has become a Rorschach test, reflecting different views on capitalism and making standardisation of measurement impossible. This ambiguity has led to critics pointing out bad metrics and companies moving the goalposts to avoid accountability.
To move forward, the professors suggest that ESG factors be separated into different buckets. Connections can be made where relevant, like recognising social justice issues when redesigning infrastructure for energy transition and resilience.
Measuring environmental factors has become more standardised, especially in tracking greenhouse gas (GHG) emissions. This clarity allows BlackRock to move into “transition investing”, which supports companies developing technologies for a lower GHG economy. There is less agreement on how to measure social topics like diversity and inclusion.
Companies are unlikely to abandon all ESG efforts despite challenges. Most businesses will continue to be bound by stakeholder pressure and regulatory moves to monitor and report simple ESG metrics, including the EU's Corporate Sustainability Reporting Directive.
Stakeholders will continue to demand ESG performance. Some experts say senior managers should align their environmental and social strategies with political considerations and include lobbying in their corporate responsibility framework.
The professors expect companies to focus on measurable and material E, S and G issues. The environment will remain a hot topic because there are fewer controversies around transition investing, which aims to enhance climate resilience by addressing climate risks.
The social is more contested, with cultural divides influencing views on diversity. The recent Supreme Court ruling on affirmative action has implications for corporate practices. Other social issues like worker safety and community impact will be treated as isolated incidents, and scrutiny will be focused on a few big companies.
ESG is at a crossroads like CSR and SRI before it, which were acronyms for corporate responsibility beyond profit maximisation. These ideals were sometimes framed as win-win and sometimes as trade-offs for positive social outcomes.
With ESG under attack, business leaders need a new playbook to decide what to include in their operations and political advocacy and how to communicate those decisions to stakeholders.
Business leaders, regardless of new sustainability reporting requirements, should take a dual approach. First, they should identify sustainability issues that impact their bottom line, like financial materiality and develop strategies to address them. This means evaluating the most critical opportunities and risks from environmental and social issues to the company’s competitiveness.
The second part of this approach is to identify and address the company’s negative impact on society. Companies should allocate resources to develop practical solutions, often working with others and advocating for policy change to create systemic change.
If we have finally seen peak ESG, firms that can address both these objectives at the same time will be the leaders in how to navigate the future complexities of business and societal issues.
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Source: Harvard Business Review
