The significance of ESG as a focus of attention within the investment community has increased greatly in the recent past. Many commentators now suggest that some measure of ESG must widen and deepen in its use and impact across the globe in the years to come. Against this background is a growing recognition that extant tools used to ‘measure’ ESG are not always fit for purpose.
Asset owners and companies offering ratings data of all shapes, sizes and approaches around the world are coming to understand that ESG investing is complex as well as diverse and is progressing at different speeds and is at stages across industries and geographies.
In constructing ESG funds, investment managers use the major rating agencies; Sustainalytics, S&P and MSCI for example, whose indexes group sets of companies that are described as good corporate citizens. This group and others, such as the Dow Jones Sustainability World Index, also rate companies on ESG criteria and sell the ratings to investment firms. These indices are widely seen to be inadequate in multiple respects. Firstly, although the quality of ESG data, indexes, ratings and tools has improved they are widely thought to require further improvements in accuracy, timeliness and greater objectivity.
The second ‘failing’ of the approach that has hitherto dominated ESG metrics is that MSCI for example, do not measure a companies behaviour as a ‘citizen’ in terms of the impact its activities might have upon the world. Rather, what is being measured is the potential impact of the world on the company and its shareholders as this is what is deemed to be most financially relevant. MSCI and others measure the degree of exposure of the company and its shareholders to the issues contained within ESG not the possible benefit to the world of a ‘better’ approach to ESG issues.
The third issue is that some investors and more recently legislators would prefer and indeed in some sectors are coming to insist, that companies large and small be held accountable for the impact of a companies behaviour upon wider society. This is putting pressure on companies and investors to change existing or develop new ESG metrics. To further complicate matters it is evident that some investors actually prefer not to invest in businesses with ‘good’ ESG ratings. The US states of Texas and Louisiana have jointly withdrawn almost $2 Billion dollars in investments from BlackRock inc. in the last year on the basis that ESG led investing runs counter to their interests.
The fourth issue and perhaps the most significant of all is that we must now confront the nature of the problem before us when it comes to the task of measuring a concept, or rather group of concepts such as ESG. What might be considered a ‘good’ technology, strategy or policy with respect to ESG is changing rapidly. This is because the ultimate goal of a positive ESG posture is both receding and evolving at an ever increasing pace. So what ESG is designed to measure will and must change in many respects in a near continuous fashion. Even the apparent clarity of purpose around the goal of achieving net zero will not, in the near term help distinguish between the complex choices that will have to be made. This is a simple statement of fact driven by the recognition that we are embarked upon system-wide disruptive change.
To give but one example amongst many that are emerging almost daily. Right now data centres are responsible for 2.5% of all human-induced carbon dioxide. That is 20% more than the airline industry and data processing and storage is certainly growing more quickly. Going digital and exploiting digital; the digitalisation of the global economy is both helping and threatening our future at one and the same time. Who must own this problem? Is it the companies that are accumulating data at a staggering rate, largely to remain unused, or the storage providers?
Our point here is that the reasons for choosing an ESG positive investment target are evolving, what such a target might look like or be doing is changing and the technical, social, political and economic factors that will interact to determine what ESG actually is are as well. What we are coming to recognise is that ESG is a form of dialectic, where competing points points of view about a subject are resolved by reasoned argumentation. In short, ESG will be produced by its use in practice and can be expected to evolve over time. Not least because what ESG is being used for is expanding quickly and so too are the definitions or expectations bound up in the concept changing as our understanding expands.
This situation is a complete example of ‘let not perfect be the enemy of the good.’ Businesses of all kinds now have a requirement to be able to see and understand what is happening and to frame that data and information into knowledge that can drive actions. The fact is however that a universally applicable measure of ESG does not yet exist and will not, in all probability ever do so. What is happening is that diverse measures of ESG are multiplying as businesses, governments, investors and indeed the public seek to better inform themselves as they invest, regulate and purchase goods and services. Even though many large companies especially multinationals are increasingly providing transparency for their actions, many more companies especially SME’s, are neither wiling or indeed yet able to do so.
What this all means in practice is that some way of measuring ESG is both extremely important and a permanently moving target. This is a problem that defines the 21st century in that what we now need to be able to is measure change itself as a priority. Because in may respects a company that acts as good citizen is one that will not simply achieve a good ESG ‘score’ as it were, but address the need to adapt – constantly. In the past we have been able to get by when measuring material objects with a relatively slow range of change e.g. cash or energy – even though even these concepts have become ever more complex. But as with so many other aspects of organised behaviour in the 21st century, what is required of us now is to be able to measure the rate of change of those factors we are concerned with. System-wide change is now baked-in to the experience of managing businesses, we need the tools that can help us understand what is happening and navigate accordingly – ESG could be one such tool in a critical area of human activity.
In our next post we will describe work exploring how we have used technology to address this complex problem. While recognising the limits of technology and the simple fact that technology alone cannot provide ‘the’ answer, we believe progress is being made.