ESG Needs a Shared Language

(Photo by iStock/bowie15)

ESG investing has been all over the headlines lately, and not in a good way. As discussions about ESG become more and more polarized—while progressive politicians push for aggressive regulations, billionaires like Elon Musk call it a “scam” and nonprofits accuse businesses of greenwashing—leaving consumers increasingly confused. As a result, as Witold Henisz puts it, the ESG movement is being delayed, which is already “having a substantive and dangerous impact,” delaying needed climate action and stymying progress towards the Sustainable Development Goals (SDGs)

However, the problem goes beyond this polarization. Even within the pro-ESG camp, there is no consensus over what ESG is, who should own it, or what should happen to formalize it. While nonprofits and social enterprises tend to want to use it as a tool to force companies to contribute to the SDGs, investors want consistent measures to evaluate financial decisions (namely risk), and business leaders want not to incur higher costs. For example, picture a social enterprise contacting a corporation with a novel solution to help achieve their newly-announced ESG targets, only to be told that the ESG leader is responsible for gathering data for disclosure purposes to investors, but not for implementing any improvements. Confusion occurs within corporations, too: imagine the regional manager of a bottling plant for a multinational corporation, responsible for reporting on key ESG metrics to one division within its company but also needing to work with innovation and product development teams, from another division, that need to start designing with ESG in mind. How can they proceed when one division needs ESG metrics for to provide assurance to investors that it is accounting for climate risk, while another is using ESG for impact and innovation?

Each of this diverse set of stakeholders has a valid claim to ESG, but they also have radically different priorities. It’s no wonder that debates around the topic between these groups often devolve into arguments, name-calling, and more shouting than listening. But if this is a problem, it’s also the movement’s potential: as a cross-sector collaboration, ESG holds out the promise of building a better planet through systems change.

One of the first tenets of systems change is that all stakeholders must have “shared language” to build trust and effectively collaborate. As Sandra Bates has put it,

“A framework for visualizing complex problems and a common language for talking about them can mean the difference between the successful execution of an innovation strategy and a frustrating, drawn-out program that yields few results.”

The lack of a common, shared understanding holds the ESG movement back, and in the confusing debate, the implementation and adoption of meaningful practices are stalled. In order to move the debate around ESG from combative to constructive, we need a shared language through which different stakeholders can express what they want out of the movement (and thus, to be able to understand what others want out of it).

ESG stakeholders typically fall into one of the following categories: Assurance, Impact, and Regulation.

• ESG for Assurance: Helping investors and business leaders make more holistically informed financial decisions, without necessarily making positive impact.
• ESG for Impact: Making progress on the SDGs so employees and consumers can make informed decisions about where they want to work and spend their money.
• ESG for Regulation: Helping governments make and monitor policies, compliance, and laws.

ESG for Assurance

ESG for Assurance exists to help business leaders and investors make better financial decisions by providing data that enables them to account for environmental, social, and governance risks. But reporting on ESG does not necessarily mean a positive impact will be created. A company might report on carbon emissions, for example, without any plans to lower them. What investors, board members, and chief executives most care about is monitoring potential risks to the financial bottom line (for example, a lawsuit for non-inclusive hiring practices, or decreased future earnings as natural resources become less available). Take cocoa companies: potential investors want to know how well the supply chain is diversified, whether the company taking measures to build preferential relationships with growers, whether the company still have access to cocoa from its suppliers in the coming years, and whether they are moving towards the organic and fair trade certifications which will result in higher prices from consumers. For investors to compare companies to make decisions, they need the companies to report on these criteria using the same measuring stick.

However, until we have a universally accepted standard for ESG reporting, it will continue to be difficult to compare ESG performance across companies using different frameworks. International bodies are working to solve that problem, and at the COP26 conference in 2021, the International Sustainability Standards Board (ISSB) was established in order to merge the many ESG disclosure standards into one, as well as encouraging the uptake of these standards globally. Tools like the Sustainability Accounting Standard Board’s materialist matrix help companies identify what they should report on.

However, ESG for Assurance does not compel a company to make progress towards the Sustainable Development Goals (SDGs). And as Peter Wollmert and Andrew Hobbs point out, the need to build consensus across the globe puts global standards at risk of being drawn down to the lowest common denominator. That’s why, on its own, ESG for Assurance isn’t enough.

ESG for Impact

ESG for Impact is about using ESG data to make progress towards the SDGs, though initiated by a company to drive business value. ESG investments provide business value in the following five ways:

1. Building the brand and attracting new and more loyal customers
2. Helping tap into new markets and customers
3. Recruiting, engaging, and retaining the best employees
4. Driving better governmental regulations and relationships
5. Qualifying for preferential treatment with other business partners and suppliers

Take a company like Microsoft, for example: They were not forced to make investments in becoming both carbon neutral and water negative, but doing so helps build good will with some of its biggest customers (including governments), as well as helping it retain and engage its employees.

However, realizing the potential of ESG for Impact still requires a universal standard to serve as a common measuring stick. Tools like the Global Reporting Initiative, Carbon Disclosure Project, Science-Based Targets (SBTis), and B Corp Assessment provide guidance to companies on how they are currently doing, and what they can do to improve. Companies can register for these tools, receive guidance on what they should measure given their industry, how to measure the metrics, and then how they compare to peers.

Social impact professionals, consumers, and employees tend to care the most about ESG for Impact. But a desire to do good from a handful of companies will not be enough to change the economy and achieve the SDGs. According to a report from McKinsey, 90 percent of S&P 500 companies publish an ESG report, but progress towards the SDGs is still behind target: “Coca-Cola and Pepsi have gotten very high E.S.G. scores and find themselves in most big E.S.G. funds, despite manufacturing products that are a major cause of diabetes, obesity and early mortality and despite being the world’s largest contributors to plastic pollution.” This is why ESG for Regulation is still needed.

ESG for Regulation

ESG for Regulation can be imposed by governing bodies, both governments and entities like the US Securities and Exchange Commission (SEC). Globally, governments have imposed a variety of ESG and CSR (corporate social responsibility) laws. For example, earlier this year the SEC proposed rules to standardize and enhance climate-related disclosures for investors. These rules don’t set specific targets that companies need to achieve, but are meant to unify ESG for Assurance frameworks for easier comparison. Still, some governments, like India and Singapore, take ESG for Regulation a step further by actually building in criteria related to ESG for Impact.

While not explicitly tied to ESG for Impact, ESG for Regulation is also required for compliance and coordinated global action.

Combining the Three to Make ESG Matter

The ESG space is rapidly evolving and expanding, and debates over meaning will be an inherent part of that process. However, to move towards a shared language, all stakeholders need to do their part to better define their language, and to be clear about it to others.

For example, a social activist attending a conference oriented towards ESG for Assurance will leave frustrated and disillusioned. While ESG for Assurance is needed, it is not the place to try and build the case for ESG for Impact (and yelling at accounting professionals to do more will only further the rift between corporations and the social sector). At the same time, investors and corporate executives need to be clearer about what is being done for business planning (ESG for Assurance) versus what is truly being done to build a purpose-driven company (ESG for Impact).

For ESG debates to lead to meaningful outcomes, stakeholders need to be more active in owning their intentions for ESG initiatives and reporting, and in labeling and communicating them. As someone working in social impact, I admit that ESG for Assurance conversations are rather frustrating and I get tired of hearing that shared standards are needed before meaningful impact goals are set. However, ESG for Assurance conversations are important to have, and should not stand in the way of other ESG for Impact conversations that can happen at the same time.

Indeed, ESG for Assurance, ESG for Impact, and ESG for Regulation are all needed for the movement to reach its full potential.

• ESG for Regulation helps set standards, ideally in line with the SDGs, that require companies to achieve ESG targets that account for their externalities and negative impacts.
• ESG for Assurance helps ensure that all reporting is done the same way so that investors can invest capital and prove the hypothesis that allocating capital to companies that prioritize ESG targets them grow and lower their cost of capital, creating an incentive for all companies to set more aggressive ESG targets.
• ESG for Impact helps companies not only mitigate their negative externalities, but also fuel innovation to build business models for the future in partnership with social enterprises. (For example, while Pepsi and Coca-Cola do have a market incentive to remove to recycled plastics, without regulation, this will not be fast enough, and there will not be a push to move beyond plastics.)

Without ESG for Assurance, we will not be able to evenly compare progress and ensure achievement, but without ESG for Impact, there will not be motivation or guidance to partner with inspiring social enterprises—like Arqlite, Baeru Environmental Services, Ashaya, or other innovators—to design improved business models that not only reduce plastic but actually remove it.

While it seems like a long way away, the ESG movement can help facilitate better financial decisions, and progress towards the SDGs, provided we can keep the discussions from creating more divisions. After all, as former CEO of Unilever Paul Polman puts it, investing in ESG for Impact to achieve the SDGs is “the biggest business opportunity of our time,” but we’ll need ESG for Assurance and Regulation in order to achieve it, and to save our planet in the process.

Read more stories by Mark Horoszowski.