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ESG’s Backlash Demands Better Data

Richard Hardyment, Head of Engagement at the Institute of Business Ethics, calls for a revolution in the mechanics of measurement to realise sustainable finance’s potential.

First there was the boom then came the backlash. ESG has stormed into mainstream finance but it’s now under scrutiny like never before. There are accusations of greenwashing from one side, ‘wokeism’ from another, and a lingering question on everyone’s lips: is it making a difference? To respond to these challenges, we need to lift the bonnet on a secret world of numbers. Because ESG is powered by data. It’s only by interrogating these magical metrics and secretive scores that we can reconfigure ESG to thrive.

Behind ESG’s phenomenal rise lies a multi-billion dollar business of data. Raters and rankers take corporate disclosures and create screens and scores, rankings and data sets. These form the basis of many funds and indices. But there’s a problem. The data providers don’t always agree with each other. For any given stock or bond, you can find dramatically different scores between the raters. If ESG measurement is supposed to be objectively scientific, how can different conclusions be reached for the same asset? This fuzziness has led some to ask: can we trust the numbers at all?

No right way to measure sustainable business

Just as financial brokers reach different recommendations on whether to buy or sell a stock, so raters and rankers should reach different conclusions about judging good business. Why? Because there is no right answer. Differences are unavoidable because sustainability is contested. Looking forward and judging risk or impact involves tensions and trade-offs, dilemmas and decisions. It involves humans in a complex dance of measurement choices.

The science should guide the measurement of sustainable business – particularly when it comes to climate goals. Are all those net zero commitments really ambitious enough? On social issues, there are norms that matter the world over. We must take the fundamentals of global standards on human and labour rights and judge all businesses by the same yardstick.

But there are no universal criteria for a sustainable society. It depends on who’s asking and why. Some activities are clearly more socially permissible and environmentally friendly than others, yet distinguishing the gradations is always controversial. Sustainability has never been without debate, dissent and challenge. There is never a fixed scope. There are no correct metrics. There is no right way to score. There is no fixed weighting to balance the numbers into a final conclusion.

The key for anyone using the data is to lift the bonnet, ask questions, sense check and triangulate, and accept that there will always be things that we can’t measure and don’t know. The usefulness of ESG data depends first and foremost on who is using it and to what end.

Standardising climate

One solution to the contested nature of sustainability has been to develop global frameworks and commonly-accepted standards. The great convergence has been promised. The Task Force on Climate-Related Financial Disclosures (TCFD) provided the foundation stone for disclosing governance, strategy, risk and targets on climate. This has been phenomenally successful. It now forms the basis for climate measurement in all global standards, including those from the IFRS Foundation.

But there’s something curious about climate. A tonne of greenhouse gas emissions is uniform and universal. It means the same thing across space and time. One tonne of carbon equivalent discharged in Shanghai means the same thing as one tonne emitted in New York. Emissions are standardised through agreed units and consistent measurement. The same is true of a handful of other topics, like water, waste and counting staff numbers and totalling up salaries and taxes paid. One unit means the same thing everywhere.

But what about human rights, natural capital or social inclusion? What is the unit for climate resilience, sustainable products or responsible lobbying? What is the metric for decent work, gender equality or responsible marketing? Almost any issue you can think of under the banner of responsible and sustainable business is neither uniform nor universal.

Complex phenomena

Sustainable business is made up of complex phenomena. These are abstract ideas that comprise many parts. When we think about an ethical culture or regenerative supply chain, we are not seeking a single attribute. Instead, the inherent complexity of these concepts means that we need to use proxies (for example: is there a policy?). The diversity of the impacts means that they only make sense in place: context matters. And all the ‘S’ issues of ESG are inherently subjective: they are based on lived experiences. Whether a workplace is free from discrimination is not something that can be uniform and standardised like a tonne of waste. It is an experience and judgement held in the hearts and minds of a diverse, dispersed population.

This is the reason why the raters and rankers often differ in their scores. There may be convergence on climate, but how far can we agree on one way to measure all the other issues? Regulated disclosures will mandate a baseline of metrics. But that doesn’t mean everyone will always agree on what good looks like. If there was one way to measure each topic, all the scores would be the same. But there’s not: it depends on the aims, scope, metrics, scoring and weighting. That’s what creates differences of opinion. And that’s what creates the market. Measuring good depends on the goals we set, the frameworks we use, the choices we make, the judgements we apply.

Responding to the backlash

Sustainable business is complex, contextual and dynamic. Its abstract nature – and subjectivity – is an accelerant in the ESG firefight that’s under way. In the culture wars of the 2020s, particularly in the United States, ESG’s value is being obfuscated. To take one example, as part of his campaign to “ban” ESG from Florida’s state investment, Republican Presidential hopeful Ron DeSantis took aim at the metrics. He slammed the measurement behind ESG as “arbitrary” and serving “no-one except the companies that created them”.

The criticism of ESG is fuelled by fuzziness: a perception that it’s all somehow about political and cultural issues, not long-term, risk-adjusted returns or greater accountability to stakeholders. There is an underlying scepticism about the standards bubbling up and a cynicism about their objectivity, accuracy and usefulness in capital markets and beyond.

Better measurement

We need to untangle these measurement knots if we are to ensure that sustainable finance can thrive. The first tangle is over definitions. ESG needs to be boldly articulated as shareholder capitalism by another lens: seeking improved, risk-adjusted, long-run returns. But there is a broader field that we might call sustainable finance. In this broader field, some start with an explicit impact objective alongside financial returns. Others want to consider ethics in investment decisions – for example, by excluding sin stocks.

Further stakeholders seek much greater levels of transparency, accountability and activism from the private sector. All these aims are legitimate in a diverse market. But they are not the same thing as ESG. We must get much sharper in our terminology and clearly distinguish the financial aims of ESG from the broader universe of sustainable finance. Don’t let the critics blur the two. We must be clear about the objective we are starting with.

Secondly, we are in a muddle over metrics. There is no right way to measure sustainable business. But there are better ways of measuring that can make the data more accurate and meaningful. We must be humbler and admit that we can’t measure everything. Proxies can get us so far, but there is an imperceptible depth to reality that we can never measure. We can’t accurately capture social issues unless we involve people in generating the numbers. What matters most isn’t always what’s accessible to measurement. If we fail to interrogate the limits to the data then the whole system is at risk of snapping under the strain when measurement falls short.

We need more humility and transparency from data providers. Some change is afoot here but we need more providers – including those using AI – to show their workings. Anyone using the numbers needs to ask tough questions. Why are you measuring? Can reality be reduced to a score? Which drivers of business value can be traced? Which are unknown or unknowable? Why might one rater form a different conclusion from another? What changes as a result of the tweaking profiles, tilting portfolios and engaging corporate boards? Share your objectives, assumptions, learnings and outcomes.

Given ESG’s rapid ascendancy, some soul searching is much needed. We need to revolutionise the mechanics of measurement to realise the transformational potential of sustainable finance. No matter what our aims – to profit from sustainable investments, improve impact on the world or better hold companies to account – measurement matters.

Measuring Good Business: Making Sense Of Environmental, Social And Governance (ESG) Data, by Richard Hardyment, was published on 10 April 2024 by Routledge.


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