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The criticism of ESG: why is it becoming controversial?
Posted on: 4 January, 2024
Despite their growing popularity, ESG policies and practices have attracted criticism from many. Here’s why.
Profit and appetite for risk are no longer the sole factor considered in investment decisions. Amid rising temperatures, global climate disasters and increasing social and environmental activism, how a business is perceived to conduct itself has become just as important as its financial forecasts and bottom line.
Environmental, Social and Governance (ESG) standards are at the heart of this shift in strategy. Since their inception at the turn of the century, the market and demand for ESG expertise and practices has skyrocketed. Research suggests that the majority of consumers and employers care, too, according to a PwC survey that found that 83% of the 5,000 consumers it polled across Europe and America think companies should be shaping ESG best practices. It also found that 76% of the 1,250 employees it surveyed across the same region would prefer to work for or support companies that share their social and environmental views.
In the eyes of many, ESG isn’t just a box-ticking exercise – it’s a strategic imperative for any organisation that wants to remain competitive and retain customers and employees.
So what are some of the biggest criticisms and concerns around ESG? Are they valid? And how do they stack up against the benefits it could offer businesses and investors?
5 growing criticisms of ESG
1. It’s just a PR move
One of the biggest criticisms of ESG is that it perpetuates what it was partly designed to stop – greenwashing. While there are plenty of benefits of implementing these initiatives, the concern is that organisations will be encouraged to adopt ESG to improve their reputation and standing among investors, employees and customers, only to treat it as a ‘nice-to-have’ – secondary to their real priorities.
Scepticism towards ESG is growing. In the UK, it’s actually declining in popularity among investors, with 53% saying they consider ESG factors in 2023 compared to 65% in 2021. What’s more, a survey from Edelman found that almost three out of four institutional investors do not trust businesses to achieve their commitments in ESG, sustainability, or diversity and inclusion.
So, while there are many parties celebrating the benefits of ESG, it seems that cases of greenwashing are diluting its popularity and, potentially, its actual impact.
2. It’s overcomplicated and too difficult to achieve
ESG covers three very broad topics – the Environment, Society, and Governance. However, while each of these topics have relationships and dependencies with one another, many are questioning the merit of applying a single ESG score when it can be such a difficult, broad and complex field to define.
For some organisations (and investment strategies), the biggest priorities that require the most attention will differ, and ESG measures that benefit one area, e.g. society, could potentially have a negative impact on another. This makes satisfying multiple stakeholders a significant challenge.
Perhaps this is why so many organisations struggle to make a success of ESG – according to a NAVEX Global survey of 1,250 managers and senior level executives, less than half believe their company performs very well at Environmental (50%), Governance (39%) and Social (37%) metrics. And while there does appear to be evidence that ESG can benefit businesses, statistics like these can be enough to put them off implementing it in the first place.
3. The way it’s measured isn’t standardised
As touched on above, there’s no standardised measurement for ESG success. With agencies like Bloomberg and Dow Jones among others offering their own bespoke rating systems (with results that can vary significantly depending on the provider), this has opened ESG claims up to scrutiny and scepticism. Criticism has also been raised at the lack of transparency surrounding the procedures agencies use to establish ratings and rankings.
However, while there have been calls to standardise ESG scores, this itself has sparked concerns that it would leave the measurements prone to manipulation, meaning a universal ESG rating system may not be the solution.
4. It’s not delivering any meaningful impact on society or the environment
The evidence of ESG’s benefits have been called into question. Some argue that, while there are statistics that illustrate a positive correlation with performance, it’s not possible for these to be directly attributed to ESG – especially when the ratings organisations receive (and the criteria used to produce them) vary so significantly.
More broadly, the relationship between ESG, sustainability, and its ability to address social issues has been questioned. Julia Binder, Director of IMD’s Center for Sustainable and Inclusive Business, discussed in an article the importance of distinguishing between ESG and sustainability:
‘The ratings and indices used by investors to identify ESG stocks are not designed to measure a company’s positive impact on the Earth and society. Instead, they assess the potential impact the world has on a company’s value and its shareholders.’
With statements like the above in mind, it’s perhaps worth assessing the way ESG is framed in conversation alongside sustainability and climate change.
5. The evidence that it delivers returns isn’t convincing
In contrast to much of the positive reception ESG has received, some evidence suggests that it isn’t even offering financial benefit for investors and businesses. A study conducted by researchers at the University of Chicago found that high sustainability funds hadn’t outperformed any of the lowest rated funds. Another study by the European Corporate Institute found that businesses with investment from ‘responsible investors’ didn’t observe an improvement in ESG scores and actually experienced reduced financial returns.
So what’s the verdict – is ESG worth your time?
The above criticisms portray a growing cynicism towards ESG that could impact its long-term effectiveness. While there is a strong case for its benefits, both from a commercial perspective and for the environment, how it can be best applied to have maximum impact and be meaningfully measured will vary widely depending on the context of the organisation in question. And, with more and more businesses being found guilty of greenwashing, businesses should take great care in its implementation to avoid doing more harm than good.