The Economist recently suggested ditching the S and the G from ESG, and to concentrate on CO2 emissions instead. This, the magazine says, is because only emissions can be measured in an objective way. We do not believe focusing on CO2 emissions alone is the holy grail.
ESG comes with several problems. First, over the years it has become an all-encompassing structure that is being used for a variety of purposes, including legislation, voluntary initiatives and benchmarks. This has made it difficult for companies and investors to make up their minds about ESG, they do not anymore see the forest for the trees.
A second problem is the measurability; definitions of ESG are wide-ranging. Whereas credit ratings overlap 99% of the time, this is the case for less than half of ESG ratings. The large demand for ESG investments in combination with the vague criteria make it well suited for greenwashing. Recently, the CEO of DWS left after accusations of greenwashing. In the US, the green credentials of DWS and BNY Mellon are also under investigation.
All these problems notwithstanding, we believe it is wrong to simply ditch ESG. Investors should not hide behind the argument of poor measurability. What to with human rights for example? Simply ignoring something because you don’t know how to measure it is not an option. Moreover, a focus on measurable elements of ESG may not always lead to the biggest sustainability gains.
It’s attractive to just focus on the clearest ESG criterion: CO2 emissions. According to this logic, pension funds would do best to divest from the most CO2 intensive companies in their portfolios. However, there is scant evidence that this really leads to higher capital costs and lower emissions for large polluters. At the same time, divestment doesn’t reduce emissions. These polluting companies should become more sustainable. Many are working on plans to meet the Paris climate goals. But for these to materialise, they need financing. Through engagement, pension funds can guide these companies in the right direction.
Moreover, a focus on reducing emissions ignores the fact that investments in renewable energy and biodiversity are also necessary to meet the climate goals. It’s difficult to determine beforehand how much CO2-reduction investments in, for example, hydrogen or negative-emission technology produce. But it’s obvious that such investments are needed.
The Economist’s call for more order in the ESG landscape is justified. The current hotchpotch of methods to measure ESG enables greenwashing and hinders discussion at the board level. It’s not at all surprising that the industry is eager to use things like the European green taxonomy and the SFDR as ‘labels’ for ESG products.
But ESG is about more than just measuring. It is about formulating your beliefs, your policies and about setting common standards. It is a continuous and complex learning process of which measuring is only one part, and not a goal in itself.
Will-Jan Jacobs and Martin van Rossum work as policy advisers for the Pensioenfederatie. Their responsibilities respectively include sustainable investments and European affairs.