The Future of ESG Is Performance (Not Ratings) 

Environmental, Social, and Governance (ESG) ratings are front and center in the news cycle these days with critique from notables like, Elon Musk labeling ESG a ‘scam’ to the Financial Times’ recently asking if ESG dead on arrival, ‘RIP ESG?’ As these ratings come under increased scrutiny from every direction, businesses get tangled in cultural and political fights around the topic and weighing market value of the ratings as the he overwhelming weight of accumulated research finds that companies that pay attention to environmental, social, and governance concern suggest reduction in downside risk, including lower loan and credit default swap spreads and higher credit ratings. At the same time, the SEC has proposed a requirement that would compel public companies to disclose their carbon emissions.

While ESG itself shouldn’t be inherently political, the data, reporting and ratings have become as messy as is the data landscape that governs it,  however, just as countries Regulatory across countries is are moving to make climate reporting mandatory there is a massive effort underway to harmonize and consolidate standards.

ESG and its ratings inherently hold value as an information source for capital markets, yet the reality is thatcustomers and employees really don’t care much about ESG ratings, just like they don’t care about business credit ratings; what they care about is that a company they do business with has quantifiable ESG metrics, transparency around progress against those metrics, and a plan for ongoing performance improvement. This is what will drive impact – not ESG ratings.

The Investment Community Has Cast A Shadow Over ESG Ratings

Call it greenwashing, call it intentionally disingenuous, but investment fund managers know a marketing opportunity when they see one. With ESG investing now the fastest-growing segment of the asset management industry, according to Morningstar Direct, sustainably managed assets in the U.S. reached $357 billion in December 2021, up 51% from the end of 2020. Given the meteoric growth of the investment sector, it’s no wonder the investment community jumped on building ESG portfolios centered around ESG ratings and large companies began pulling to levers to improve those ratings.

The analysis for those ratings is shrouded in mystery, and with every ratings company having its own evaluation system, investors may mislead shareholders over the actual performance of companies regarding ESG topics. This month, Goldman Sachs is being investigated for having omitted or misled investors about its ESG criteria for assessing investments. The SEC is also looking into Deutsche Bank for the same unverifiable promises. There is a clear signal that people want ESG investments, and that they just want them to be better defined and verified to avoid ‘greenwashing’ or ‘greenwishing’ in hopes of a better future, e.g., the pursuit of actual ESG performance.

ESG Performance Is Already Top Of Mind for Business Leaders

Even as it’s become a hot button issue within the investing community, ESG performance is and remains incredibly important for business leaders and consumers who demand action from governments, themselves, and businesses when it comes to the climate catastrophe. Buyers are demanding better ESG performance from the products they buy, the companies that operate in their communities, their employers, and the values they espouse – everyone is watching, and they aren’t watching for ratings.

Therefore, business leaders are taking the lead on ESG as a matter of future survival – reputational, corporate, and planetary. They know that the companies that adapt quickly and focus on quantifiable ESG performance are best positioned to benefit overall. It’s clear that ESG principles will play a vital role in supporting core business aims and holding one’s position at the forefront of an industry. And, as a requirement given the coming SEC reporting disclosures.

The SEC Steps in To Govern ESG Performance 

On May 25, 2022, the SEC proposed new rules that would require publicly traded companies to  accurately measure greenhouse gas emissions and disclose strategic planning around climate-related risks and opportunities. The SEC’s aim is to protect investors and demand that ESG funds substantiate that label if they’re going to profit from it. The question is, what really should qualify a business for inclusion in an ESG fund or listing, and is it a rating or should it be a clear path to performance improvement?

ESG Performance Should Be More Like Credit Risk Ratings

In his three-part GreenBiz series, “Are ESG ratings really necessary?”, Joel Makower suggests that, “ESG ratings would be better if rolled into a singular system with credit ratings.” Makower adds that, “[ESG ratings] are primarily about risk to companies, not necessarily their impact, positive or negative, on people and the planet.” While the ratings have proven to play an important role for the ratings companies, they’ve failed to help companies improve on ESG performance and identify opportunities for improvement. What we need is better tracking of ESG progress against a set target in the areas that matter most and verifiable metrics. 

ESG ratings would be better if rolled into a singular system with credit ratings. The ratings are primarily about risk to companies, not necessarily their impact, positive or negative, on people and the planet.

Joel Makower, GreenBiz

We’re still learning when it comes to ESG – it’s a new domain. It’s been only a hundred years since the SEC was established and modernized the entire field of accounting into what we’ve come to accept as good practices today. And the companies that are carefully measuring and reporting on their performance are contributing to a more reliable and usable quantitative future of the industry and reaping the benefits. When it comes to ESG performance, there’s no question about whether to do it, the train has already left the station, it’s about the right way to go about addressing and improving on ESG.

What To Do Next

Stop focusing on external ratings and build a performance focused ESG strategy. Understand what ESG topics and concerns your stakeholders are most interested in. Define your company’s material ESG topics. Consider in what part of your business you can realistically make the largest ESG impacts. The data collection process is next, where you will need to possess the necessary data extraction and reporting capabilities.

If you have been overly focused on rating and need to refocus your ESG strategy on driving performance, our team of experienced sustainability professionals can work with you to deploy our integrated ESG software platform and work alongside your team to craft a performance focused ESG program to accurately to track and report on ESG progress. It is only in being transparent about the challenges can we seek out the solutions to improve our ESG performance. Good.Lab provides a combination of software and a network of experts to help you build your ESG performance improvement roadmap. Let’s talk about your company’s ESG performance today.