From ESG to SOcial risk
Environment, sustainability and governance (ESG) sits at the heart of how many responsible companies have sought to operate and track their progress for close to two decades. ESG has become a controversial topic in the US, with major corporations including McDonalds backing away from using ESG criteria in their reporting and public material.[1] Companies are pulling back from associating with ‘ESG’, even while they may not be backing away from their commitments to doing good within their community.
So what digs?
It helps to understand ESG in two lights. The first is a set of reporting or measurement criteria suited to tracking company performance on issues relating to environmental stewardship, sustainability and governance. ESG is one approach to mitigating ‘social risk’. Roughly put, social risk is the possibility that a company will incur material, financial or reputational damage due to their performance (or lack of) on issues that people care about.
The second is as an investment asset class, or as a method for grouping certain assets based on ESG reporting criteria. There’s some conflation in how ESG is used, and it’s the tension between ESG as a legitimate qualifier of corporate performance, and ESG as a profit making vehicle that has led to ESG becoming a poisoned chalice for a number of major corporations.
ESG assets first appeared in 2006 following the announcement of the United Nation’s Principles for Responsible Investment. [2] By 2020, the value of ESG assets under management had grown to a whopping $35 trillion. The apparent logic behind investing in this asset class is simple: companies that care will prosper.
In the US, ESG assets and ESG reporting criteria have been embroiled within a political row surrounding the fiduciary (a fancy word for maximizing profits) responsibility of retirement fund managers. With republicans essentially posturing that ESG metrics do not warrant legitimate investment decision making data[3], and democrats arguing that they do[4]. Amidst this debate, ESG both as an asset class and as a reporting standard - have become politicized.
Companies are starting to avoid ESG because of its deepening association with partisan politics. Republicans have labelled ESG a part of the ‘Woke ESG Agenda” and depicted it as an effort towards “strong-arming and intimidating corporations and investors alike…”[5] This volatility has had a dire impact on public and corporate support with CNN reporting that that the total value of ESG funds fell by some $163 billion globally during the first quarter of 2023 from the year before.[6] Ironically, the exodus away from ESG is due to a growing sentiment that ESG itself has become too socially risky.
The future appears uncertain for ESG, but this exodus away from ESG reinforces the ongoing importance of social risk management and mitigation in the business world. A broader shift away from ESG would not be a total loss. As both a reporting standard and an asset class, ESG underperforms[7]. There is no evidence that companies within ESG portfolios outperform non-ESG, low-sustainability companies[8]. On the other hand, there is evidence that companies qualifying for ESG portfolios often perform worse than their non-ESG fund peers on labor force and environmental issues[9]. In many cases, ESG criteria have little impact on a company’s relationship with their host community, and don’t reflect where a company has its greatest impacts on that community.[10]
There are many companies striving to do good in their communities who find themselves in a bind. On the one hand, they have an ineffective assessment and reporting standard. On the other, they have an increasingly discerning, critical public that is capable of monitoring their performance on issues that count. One solution for this group of companies is to move beyond ESG through a focus on community-centred social risk and social impact management.
ESG fails because it lives in a vacuum: it’s not responsive to the unique contexts, needs and aspirations that shape relationships between a company and its host community. There can be no one-size-fits-all approach to navigating the social risk landscape, when every landscape is different. AntHill helps companies to move beyond ESG. We specialize in helping organizations to build detailed, community-centred understandings of their social risk landscape, identifying common ground in what people care about, and designing strategies that build shared value and generate enduring, positive social impacts.
The future for ESG might be uncertain, but the future for those seeking to do good and play a leading role within their communities is as bright as ever. If you or your company is ready to move beyond ESG, we’d love to hear from you.
[1] https://fortune.com/2023/08/11/mcdonalds-removes-esg-from-parts-of-website/
[2] forbes.com/sites/betsyatkins/2020/06/08/demystifying-esgits-history--current-status/
[3] https://www.nytimes.com/2020/06/24/business/labor-retirement-investing.html
[4] https://www.nytimes.com/2023/09/21/business/texas-judge-esg-biden.html
[5] https://thehill.com/policy/energy-environment/3877592-house-approves-measure-targeting-biden-rule-allowing-esg-investing/
[6] (https://www.cnn.com/2023/10/03/investing/premarket-stocks-trading/index.html)
[7] https://hbr.org/2022/03/an-inconvenient-truth-about-esg-investing
[8] https://onlinelibrary.wiley.com/doi/abs/10.1111/jofi.12841
[9] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3826357
[10] https://sharedvalue.org.au/wp-content/uploads/2019/11/Where-ESG-Fails-_-Institutional-Investor.pdf