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The ES(g) Dilemma

The ES(g) Dilemma

If we are to give in to the popularity and idealism of policy makers and environmentalists, it would seem that we have an answer to the ESG paradox that has plagued the investment world for about two decades and triggered so many debates as to whether for-profit organizations can really aid in preserving the environment and encourage sustainable and ethical investment behaviour.

At the time of typing this, Google returns 508,000,000 results on the term; a hot topic by any standard. So, what is ESG after all? “ESG” is a concept or rather a set of standards purporting to balance financial outcomes against the impact business has on society, the environment and corporate governance. Nowadays, strong ESG scores act as a corporate badge of honour as they (appear) to attest to an organization’s (a) environmental footprint and response to climate change, such as on reduction of carbon emissions and waste production; (b) relationship and responsibility towards people, society, and human values in general; and (c) a sustainable, transparent, and responsible decision-making structure within the business. Out of these, it would seem that “E” and “S” could live without the “G”, however, as discussed further below, the truth is that both of them are contingent upon the existence of the latter in the equation.

Though originally driven by good intentions in improving the world around us, the hard truth is that, currently, ESG does not, and (potentially) will not, resolve the generational challenges faced by society. The trillions of US Dollars invested aim to generate profit to the people that have allocated and risk to lose them (whether institutional or retail investors) rather than having been consciously dedicated to save or improve our society and the world. To quote an international news outlet take on the situation, ESG ratings measure the potential impact of the world on an organization and its shareholders rather than the impact an organization has on the world. In support of this, research data suggests a tendency towards misleading and, arguably, deceptive “greenwashing” tactics by organizations, whose aim is to highlight a shift towards an ethical and environmentally conscious friendly business policy. Others have leveraged on the opportunity and found new ways of generating income and/or maximising profit – take for example the creation of new investment strategies and products targeting a new group of investors, along with the associated fees and costs.

The irony of the ESG is that the political establishment dictating on how investment professionals should safeguard client money and conduct business, is the very one that is influenced, and, in certain cases, funded to promote the ESG policies it advocates. This article does not intend to argue for or against ESG but rather it is an attempt to put forward a few thoughts on how to improve/strengthen its application by touching upon the “G” factor.

Recognising governance as a foundational pillar of ESG is crucial for organizations aiming to create long -term value, foster stakeholder trust, and align their interests with those of potential investors and the wider public. A strong governance framework ensures accountability, transparency, and ethical behaviour, ultimately contributing to the organization's overall sustainability and positive impact on society and the environment.

Zooming into governance, it becomes clear that it is concerned with how an organization operates in terms of, amongst other things, its board diversity, internal controls, shareholders, controls, audits and policies, including compliance and anti-corruption policies. This could also include taking measures to ensure that the rights of the directors, shareholders, management and / or employees are adequately protected and helps to ensure alignment of their interests together with the interests of investors and the public. Notably, there has been a shift in practice recently by also focusing on the interaction of an organization with stakeholders like suppliers, competitors, and governments in an effort to balance the compliance with market preferences, while maintaining a sustainable business plan.

The metrics that can assist in evaluating corporate governance performance are quite complex and variable. However, there are certain key areas that corporate bodies could focus on improving, to ensure good corporate governance, including the following:

  1. Board composition, quality and integrity
  2. Ownership and shareholder rights
  3. Remuneration
  4. Risk and crisis management
  5. Relationship with stakeholders, i.e., shareholders, employees, suppliers, customers etc.
  6. Ethics and transparency

Combined, these elements would unavoidably provide the ground for enhancing ethical conduct, transparency, and responsible decision-making. Board composition, quality, and integrity lay the foundation for effective leadership, ensuring diversification on perspectives and expertise. Ownership and shareholder rights generate confidence among investors, fostering a sense of ownership and alignment with the organization's vision. Emphasizing on fair remuneration practices not only fosters a culture of fairness but also serves as a strong incentive for sustainable performance.

An organization’s readiness to handle challenges is showcased throughout risk and crisis management strategies. Maintaining positive and open relationships with stakeholders reinforces the organization's commitment to fulfilling their expectations, whilst upholding strong ethics and transparency builds trust and strong relationships with all stakeholders, driving sustainable growth and positive impact. On a similar note, emphasizing proper accountability and transparency in governance fosters a positive corporate culture that attracts socially aware investors, engenders stakeholder trust, and positions the organization for long-term success.

As “E” and “S” continue to take the central stage, it is crucial to acknowledge the “G” force within the ESG context; even more so when dominant investment profiles become younger and traditional investment norms across the financial services landscape shift to a more responsible investment approach.

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