ESG Faces Challenges But Investors Show Little Sign Of Giving Up On It

These are interesting times for those focused on making businesses more accountable for the issues that have come to be grouped under Environmental, Social and Governance. For a start, German officials are investigating allegations of “greenwashing” — making misleading claims about environmental credentials — at DWS, an asset manager that was formerly part of, and is still majority owned by, Deutsche Bank. It is feared that the action could lead to similar claims across the investment industry. Then there is the matter of Stuart Kirk, who was suspended as head of sustainable investments at HSBC’s wealth business after claiming that the climate risk to investors had been overstated by ESG advocates and central bankers. Finally, there is the changed geopolitical situation. The war in Ukraine, the continuing fall-out from the pandemic and the associated cost-of-living crisis afflicting many western economies have put governments, and business, on the back foot and forced them to confront more immediate issues, particularly energy and food security.

Even without these factors, ESG proponents face challenges. Chief among them is the confusion caused by a lack of clear reporting rules and the difficulty of collecting data in areas that are hard to measure. At last month’s World Economic Forum’s annual meeting in Davos, Alan Jope, chief executive of Unilever, defended the multinational consumer goods company’s continuing focus on sustainability but warned of the need for a single set of ESG reporting standards. “We are at a point of great danger right now of letting perfect get in the way of good, of letting complex get in the way of simple and of letting local get in the way of global,” he said.

The problems associated with collecting even the most basic information were highlighted in a recent report commissioned by the Banque Cantonale Vaudoise and the University of Lausanne to assess the ESG quality of a real estate portfolio. It found that obtaining quantitative information on the portfolios was particularly challenging. “It appears that many entities are not yet equipped to deliver accurate numbers on various environmental dimensions of their portfolios,” it said. It added that energy clearly seemed to be at the forefront of concerns. “Very few entities report on water usage, waste generation, or biodiversity. In this respect, there appears to be a gap between intentions through the policies put in place and the actual tools for measuring the real situation,” the report added.

Professor Eric Jondeau, co-director of the Center for Risk Management Lausanne at HEC Lausanne, University of Lausanne, and one of the authors, said in an interview that the research revealed that, while progress was being made, much needed to be done to ensure consistency in reporting from different types of funds. Pointing out that smaller funds that were not part of bigger businesses and therefore subject to tighter reporting regulations were lagging behind in collecting data, he suggested that one reason might be that they did not feel they needed to because they didn’t have investors driving it. Another problem was that there was a clear need to invest in making buildings more efficient but that there was little incentive for landlords to do this because renters would see no benefit and therefore would be unlikely to accept increases in rent.

One way Jondeau and his colleagues see things improving is through being able to score funds so that investors know more about what they are doing and can act accordingly. This pressure to do what is required is certainly being felt at board level, according to Andy Davies, a senior partner at executive search firm Kingsley Gate Partners, who says that the reputational damage and costs of not complying mean that ESG issues can no longer be ignored. He has seen a number of different approaches adopted in response. In some cases, organizations create a position that has sole responsibility for the area and this can be an executive or non-executive role. In others, they just add the responsibility to the audit committee — although he notes that audit committees probably have enough to do already. Finally, they create a stand-alone ESG committee that reports separately.

Whichever approach is taken — and Davies insist there is “no one right answer” — the challenge for people like him is to find individuals with an unusual combination of skills to fill a role that in the last 12 months has become seen as increasingly important as companies are either held to account or see the value of having a clear ESG policy. Those who succeed are likely to be analytical with an understanding of finance and risk and are also evangelical with strong communications skills to ensure they can create the case internally and communicate it externally, he says, adding that the seniority of the role is likely to increase as organisations realise its importance.

Somebody who understands this well is Maja de Vibe, senior vice-president, sustainability, governance and compliance at Statkraft, which is owned by the Norwegian government and with a 125-year history in the sector claims to be the largest generator of renewable energy in Europe. In a 20-year career she has worked in the areas of governance, sustainability and anti-corruption for governments and advisory bodies as well as business, a combination that she says has proved valuable in giving her an appreciation of the practicalities of implementing policies.

One aspect that she says is becoming increasingly clear to analysts and observers in addition to the companies involved is how the “revolution of switching from fossil fuels to renewable energy does bring with it some trade-offs and dilemmas.” The most obvious, she adds, involve the impact on nature and on communities.

Acknowledging this is significant because for many years a company in a “green” sector such as renewable energy was generally regarded as being — as de Vibe puts it — “home-free” in terms of sustainability. Now, it is incumbent on such businesses to do as much as, if not more than, others to mitigate the effects of their activities, whether in the materials used, their approach to supply chains or in the sites chosen for building. Given her previous experience, de Vibe is particularly concerned about the risk of renewable projects becoming susceptible to money laundering. Inevitably, when a sector attracts interest and incentives, as has been the case with renewables, certain types of players become involved, with the result that there have been, she adds, “spectacular cases” of fraud and money laundering connected to renewable energy assets.

As “a state-owned company with very high expectations on these topics,” her own business also had “a very stringent and conservative approach to business ethics, governance, anti-corruption type of issues.” But it is consciously stepping up its own performance in such areas as managing emissions and recycling in order to be more responsible and proactive.

There has been some talk of sustainability targets being relaxed because of the straitened circumstances in which many governments find themselves, especially with regard to energy. Meanwhile, some right-wing politicians have used the situation to push back against what they see as business becoming too involved in social issues. But de Vibe sees little signs of the pressure to meet ESG goals easing. In Europe, companies face a sharp shift from the situation just a few years ago when they could write their annual sustainability reports more or less how they saw fit to having to meet stringent reporting obligations. Moreover, new laws being developed could expand the remit to include a requirement for companies to demonstrate due diligence in regard to human rights. The idea is that a sort of positive competition will develop with companies wanting to impress investors and others by going beyond what is legally required.

In a sign perhaps of how the financial sector has moved to embraced thinking that not so long ago was viewed as utopian and impractical, Brian Moynihan, chair and chief executive of Bank of America, told the Davos meeting that the war in Ukraine was not a setback for ESG. “I don’t think that there’s a way to walk away from it,” he said. “Because your customers won’t let you, your employees won’t let you, your shareholders shouldn’t let you and, by the way, society won’t let you.”

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