Societal Tool Or Corporate Distraction?

ESG investing has become a hot-button issue, within fintech and beyond, that has moved from the investing community into family dinners and corporate investor calls. Environmental, Social, and Governance has become a kind of Rorschach test where each side of the political, corporate, and investing spectrum can see whatever they want. But ESG practices are much more than meets the eye and stakeholders would do well to ask themselves what ESG means in practice. So what actually is ESG investing and what are its real challenges?

In a recent episode of The Pnyx, a debate podcast hosted by yours truly, Charlotte Degot and Hans Taparia explored some of the key tradeoffs in thoughtfully implementing ESG practices.

Perception vs Reality

The rise of ESG corporate strategies has driven a wedge into the manager/investor relationship. Apart from the recent political drama surrounding ESG investing, some investors still perceive ESG practices as a cost center and not a value add. But for most multinationals, ESG practices have become a need-to-have, not a nice-to-have. Whether navigating the Black Lives Matter movement or cable news television, c-suites have had to pick sides and to stick with them. The Social and Governance parts of the ESG strategy are effectively mandatory in the multinational world. However, the Environmental aspect of ESG still sees resistance between corporate management and investor sides. On the podcast, we discussed how the first way to solve this problem is to offer clear metrics of what a firm’s ESG practice actually means.

Existence and Effectiveness of ESG Metrics

Clean, consistent metrics are the biggest gap in the ESG investing world. How can anyone (corporate, non-profit, investors, etc.) identify progress without good data? Our guests emphasized that measuring ESG strategies as well as their successes remains a considerable challenge because the industry has no consistent criteria. Different ratings agencies use completely different methodology and grading for ESG investing. Compounding the problem is that ratings groups have as much incentive to market their proprietary ESG metrics as much as they do to actually perfect them. These ratings agencies are racing against each other to have their metrics be the standard gauge all others use. If investors want to drive progress in ESG, we will need to align our definitions of success before we can ever succeed.

Balancing Corporate Profits and Sustainability

Beyond simply green-washing corporate practice, investors and corporate managers often do see eye-to-eye on their ESG goals but cannot agree on how to achieve them. One of the main challenges our hosts discussed was the balance between short-term losses and long-term gains in the ESG investing field. Often, when corporations undertake a new ESG-oriented objective, they bear the cost up front and must recoup their profit later. Making sure that investors and managers are aligned on the means of achieving their ESG goals is almost as important as ensuring they share the same goals. Further, we question how to measure each element of ESG against the other; if E is strong and SG lag, does it really make sense to throw the baby out with the bathwater?

We believe this problem can largely be solved by embedding the ESG practices (not just the metrics) directly into a company’s core business. By demonstrating the need-to-have’s overlap with the nice-to-have, companies can easily demonstrate to investors the value of their ESG projects. For example, Coca-Cola
KO
in India began investing in water stewardship practices after much criticism about its water usage and waste. Coca-Cola realized there was overlap between its need to cut the amount of water it used to produce its beverages and the kind of waste it created. By using less water (down to 1.78 liters of water to produce one liter of beverage from 2.16 liters in 2018), Coca-Cola India reduced costs and improved its water use footprint.

ESG Meets Fintech

Given your writers fintech focus, it is incumbent on us to note the various ways fintech innovation has a role to play here, in generating the right sets of data and helping building toward this balance. Companies like Clarity can help manage ESG-related data so that the right inputs are available, and Novisto helps do the ESG accounting required to measure the outputs. Models like Ethic are working toward customizing ESG portfolio across investor groups. Fintech as a horizontal service will play a key role in getting ESG right.

ESG’s Long-Term Impact

Beyond the immediate balance between the ESG operator and the ESG incentivizer, ESG investing as a field is far too new to have any clear achievement across the industry. What effect does ESG investing actually have on a country’s economy, let alone on the planet as a whole? What are the measurable consequences of not pursuing ESG investing? Only time will tell how successful these efforts have been.

ESG investing is no silver bullet for the climate crisis. The panelists on our podcast argued that it is merely a tool for ensuring people calculate the externalities (and increasingly the internalities) of their investment decisions, and we agree. But ESG will not singlehandedly solve the great challenges either industry or society faces writ large. Until we have bigger solutions, ESG investing will have to focus on both the critic and the critique if we want to make a lasting and positive change on our planet.