Why ESG can be misleading and what can be done to protect...

Why ESG can be misleading and what can be done to protect ethical investment

With sustainability becoming an increasingly significant consideration for discerning investors, being able to differentiate between true sustainability and merely a green veneer – or, ‘greenwashing’ – will become increasingly important as time goes on. That is why Tribe Impact Capital wants investors to know the risks of relying on ESG (Environmental, Social and Governance), and how a promising acronym might just be another way of pulling wool over consumers’ eyes.

According to the Tribe analysis, ESG has become a ‘powerful framework’ for businesses to consider their operational risks by using a shared language, and to provide shareholders and lenders with a gauge of the extent to which companies identify and mitigate against these risks.

However, despite encouraging steps in the right direction, and introducing sustainability vocabulary into corporate discourse, a major problem with ESG data sources is that the consumers are led to believe assertions of ‘sustainability’, ‘responsibility’ and ‘impact’ often provided by a singular piece of publicly available information.

According to Tribe, ‘genuine sustainability’ requires engagement with a business’ products, services and history, and needs to be based on data from multiple sources and specialists.

Indeed, if we look at oil and gas blue chip, Shell (although you could pick many), the company posts ESG reports, yet its operations are anything but sustainable or ethical. Indeed, even after undergoing seemingly radical CSR reforms, its operations in Nigeria remain the subject of regular controversy.

Between providing funding for munitions to suppress protestors (as declared in US Embassy cables in 2006); to being complicit in a $1.1 billion bribery arrangement in 2011 (as reported by global witness); tax irregularities valued at $1.67 billion between 2004 and 2012 (ActionAid); and 1,010 official oil spills between 2011 and 2018 (Amnesty), One might think of RDS as a prolific offender.

What makes Shell so interesting, though, is that their CSR initiatives are often touted as some of the best in the oil industry, and that should give us some sense of why using cheery acronyms, such as ESG, is often misleading. According to Tribe’s statement:

“Over the last few years we have seen examples of businesses that would never be recognised as responsible or sustainable, due to certain business practices identified in the impact due diligence process, appearing in active and passively managed funds under an ESG banner across sectors. From the financial sector – a bank getting exemplary scores for governance yet investing billions of dollars into Tar Sands exploration businesses for example, to within the clothing retail sector – where large gaps in data and scrutiny on both the environmental and social impact of production were overlooked.”

“Problems then arise in both hoped-for impact and financial returns. This misrepresentation is misleading to investors and opens them up to the exact risks they were seeking to protect themselves against with a sustainable investment strategy. It is therefore critical investors don’t fall into the trap of taking too much comfort from ESG data’s protective blanket and failing to interrogate a business’ strategy in a more holistic manner.”

The solution Tribe would suggest to this dilemma, would be a greater focus on impact investment. In Tribe’s investments, they focus on businesses working to affect positive change, and they use the UN’s 2015 Sustainable Development Goals as a framework to guide their efforts. Or, as Tickr Co-Founder, Tom McGillicuddy, put it: investing in companies with a business model built around creating a positive impact.

Another solution is put forward by the Temple Bar Investment Trust Director, Dr Lesley Sherratt, who suggests that another way to make companies more sustainable is by institutional investors moving the goalposts of what can be considered Responsible Investment. Using this approach, Sherratt appreciates the majority stake that the likes of pension funds and investment trusts have in buying shares, and states that if they were to apply more limited but demanding criteria, then companies would be obliged to change their business models, in order to be eligible for Responsible Investment portfolios.