Richard Costa, director at FleishmanHillard and head of corporate reporting at Ensemble Studio, looks at the myths, perils and benefits of ESG.

The audience was stunned. During his presentation at the FT Moral Money event on 19 May 2022, Stuart Kirk, the head of responsible investments at HSBC Asset Management, was adamant: “Climate change is not a financial risk that we need to worry about.” Was he breaking rank, or shining a light on widespread insincerity?

The separation of profit and planet is by design. ESG investments are rated on how the operating environment may affect profits, not the reverse. The financial data and media company Bloomberg puts it neatly: “[ESG] ratings don’t measure a company’s impact on the Earth and society. In fact, they gauge the opposite: the potential impact of the world on the company and its shareholders.”

Fighting climate change is one thing, measuring and assessing the climate risk to a firm’s profits is another. While ESG investing might be a way to measure risks to corporate cash flows, it is no way to advance planetary sustainability. Asset managers are trained, incentivised, and bound to maximise their client’s returns. It is naïve and unreasonable to expect them to put public interests ahead of their clients.

ESG is in high demand. The acronym generates hundreds of millions in fees, with the label now being slapped on everything from loan products to investment bonds. The fees for managing ESG funds is typically higher, making them a timely answer to tightening margins. Sometimes the premium is unwarranted. In February 2022, investment advisory firm Morningstar removed the ESG tag from more than 1,200 funds because they did not “integrate [ESG factors] in a determinative way.”

In April 2022 billionaire activist investor Carl Icahn said Wall Street’s ESG efforts may be the “biggest hypocrisy of our time” with firms cashing in on the feel-good acronym without concern for actual impact. Investors must “back up their words with actions,” he said. Annual reports and marketing materials make lofty statements about corporate aspirations, but the authenticity gap has deep consequences. The impression that the money needed to tackle global issues is upcoming undermines the necessary regulatory reforms and public-private partnerships that would make the difference.  

Blinded by a thicket of ESG metrics, targets and ratings, managers can miss the point of why they are measuring in the first place: to ensure that their business endures. A precondition for sustaining success is to manage its ‘externalities’. The expression is entering common parlance. That’s because people care. Companies may conduct their operations in a seemingly rational way, but if they assume that their operations don’t have ripple effects, or that there won’t be an erosion of public trust by failing to address them, their prospects may be unachievable.  

Corporate sustainability plans should include how stakeholders perceive the business and ways to prevent or manage potential reputational controversy. This can create a moral hazard. Sometimes, it may be easier to sugar-coat the status quo, or create false impressions about the underlying business model.

Greenwashing is inherently linked to the question of integrity, or the lack thereof of those who practice it. In their account of the ‘G’, too many corporate ESG reports omit how the board of directors creates a culture of sustainability. In this respect, all relevant stakeholders should be taken into account, from employees to suppliers, customers and regulators. It is revealing how annual reports tend to gloss over disclosures like ‘stakeholder engagement’, ‘s.172’, and ‘risk management’.

The emergence of ESG as the benchmark of sustainability has all too often gone in hand with hypocrisy. Corporate leadership should set the example. Change must come from the top.