Is the ESG narrative finally returning to value?
Three narratives emerge that attempt to clarify ESG
Since starting the ESG Advocate, I’ve written extensively about the anti-ESG pushback and the conflation of sustainability values with ESG. These two things are related, but the former is uniquely a North American issue, as my friend Alexandria Fisher calls out via Google Trends.
The EU is pushing ahead with new ESG regulations with CSRD, and companies are preparing. Still, North America, especially the US, continues to stall, despite new SEC rules coming as soon as April. Much of this concerns the latter point above and the mistaken belief that ESG is imposing values on shareholders and therefore sacrificing returns.
This narrative is ubiquitous, which is one reason I started writing about ESG in the first place. Beyond this blatant political rhetoric, writers in major online journals often get this wrong because the markets have intentionally gotten this wrong. There are paths to align with values, but they aren’t necessarily ESG. Still, an over-eager financial services sector chasing more fees and opportunistic boards have latched on to the ESG narrative in this way in an attempt to capture short-term value for themselves.
This year is already showing signs of change through recaptured narratives. Let’s look at three ESG narratives that have been building for a while but appear to be making headway.
Narrative 1: ESG has value
ESG is a complex topic as the current narrative is torn between ‘you’re not doing enough’ and ‘you are doing too much.’ Carlyle’s recent 10K filing is worth a read as it demonstrates this ‘can’t win’ situation that financial services firms find themselves in. Surprisingly, I haven’t seen corporates call this out yet. Below, Carlyle calls out the balance between these two opposing forces and the potential impact on results in the first two paragraphs.
Throughout the rest of Carlyle’s 10K, they explain how they leverage ESG to drive value, which is critical for any company, not just financial services firms. In addition, they do an excellent job explaining ESG and its value proposition on page 14 (highlights are mine).
ESG. We are committed to the principle that building a better business means investing responsibly and engaging in the communities where we work and invest. As a responsible global organization dedicated to driving value by seeking to serve its stakeholders, Carlyle has made it a priority to invest in a framework and the necessary resources for understanding, monitoring and managing environmental, social and governance (“ESG”) risks and opportunities across our portfolio. We believe ESG provides an additional lens to help us assess and mitigate risks, and identify and capitalize on potential opportunities.
A quick search of the SEC’s EDGAR database for “ESG” mentions from the past year of 10K’s shows a mix of ESG interpretations, including:
The appearance of the acronym (with little explanation)
A conflation of ESG and values with little focus on value
How Carlyle describes it (although rudimentary in most cases)
I hope companies take note of Carlyle’s phrasing, adopt the methodology, and, most importantly, practice it. Higher quality and consistent messaging across 10Ks would be bound to garner attention and, come time for Congressional ESG hearings, could help clear the air. Not to mention that getting hung up on the values vs. value discussion will yield little and place boards in precarious positions if they ignore it entirely.
Narrative 2: You are already addressing ESG issues
Lately, another narrative shows that ESG isn’t as unique as it may seem because you are already doing it. Alex Edmans published The End of ESG, which argues that ESG isn’t different from things that investors and boards focus on already to drive long-term value. We looked critically at the paper here, but Edmans is right. If boards are operating effectively, they should be focused on these material issues to drive long-term value.
The problem is that boards aren’t getting it, and if you listen to the Business Pants podcast, it is blatantly apparent. The 20th edition of the What Directors Think report from Corporate Board Member revealed 50% of surveyed Directors say ESG is getting too much attention in the boardroom. Yet, most of the external factors impacting a company, if not all, are ESG factors.
This led Dan Bigman, Editor at the Corporate Board Member, to declare that maybe ESG needs a better publicist because companies are already addressing ESG issues.
Many boards do not understand ESG and appear to equate it with costly disclosure and reporting exercises, which sometimes can be. So when asked, executives hate ESG. For example, companies focus on carbon disclosures due to impending regulations and climate change attention, but carbon isn’t material to every company. This makes it concessionary for companies to deal with between tooling and specialized staff, especially across large, complex value chains. This can leave smaller individual players in those ecosystems scrambling to provide data with no assistance whatsoever.
Executives need to understand that ESG is the long-term value they are already working towards (hopefully) and find the value within the acronym. Boards are already working on some ESG issues, but not all understand the material intersections around their connection with how the world has changed through interconnected risks. As Edmans’ article makes the rounds again on LinkedIn, it’s worth calling that out. This concept is reflected in the Carlyle quote above, i.e., ‘additional lens.’
For this narrative to take root, boards must operate well and explain their successes.
Narrative 3: There is materiality, but also value in the values
Early in January, George Serafeim, author of Purpose + Profit, appeared on the Fix the Future podcast to discuss ESG.
ESG, at least in my mind was never meant that it will save the world. There are several people that think that this is a mechanism or it has been advertised as a mechanism that it will save the world. That is will solve, basically, poverty and inequality and climate change and water scarcity and so forth and it cannot do that, right.
It wasn’t meant to do that, it is a framework through which organisations are trying to measure, analyse, drive performance and communicate key performance indicators that are actually, relevant for them.
Serafeim nails materiality in that last line as ‘relevance.’ ESG represents those issues that are relevant to the company.
The clarity continued to show up in a few more places. Andrew Winston wrote an article titled ESG Is Going to Have a Rocky 2023. Sustainability Will Be Just Fine. The title goes against my hope, but the description of ESG in the read is another example of this narrative in action.
ESG is not sustainability. ESG — the acronym stands for environmental, social, and governance — has been mostly focused on screening companies as investments, largely by understanding how a business is affected by environmental and social issues (with an additional focus on whether a company has good governance in place to manage those risks and pressures). Sustainability is a much broader idea, focusing on a company’s role in society, how it creates value by managing its environmental and social impacts (both positive and negative), and how its actions affect a wide range of stakeholders.
Winston articulates the intersection of ESG and sustainability efforts in simple terms. Yet, it is here where I observe people struggle the most. This is the root of the conflation, but he explains where values and value meet—at the stakeholder.
Pleasing stakeholders and serving the common interest, including the planet’s, is how to create value today.
Putting Serafeim’s spin on it here, serving the common interest IS relevant, or material, because it is how to create value today.
No matter how you look at ESG, even through the lens of values, there is a connection back to a value somewhere, which is the point. For boards, this means focusing on the relevant matters, not only philanthropy. That can be great to do but can become a purposeful distraction from the business. Further, if a philanthropic project isn’t material to your business, the company may flail while running a failing project.
The reality is that anti-ESG is expensive, regardless of the story
And so, there may be hope if this wave of recent narrative shifts continues. Still, nothing changes minds like a measurable financial risk, which isn’t always immediately available with ESG due to its long-term view. In a world of short-term gains and quarterly reports, ESG’s value can be fuzzy and appear non-pecuniary.
So, let’s revisit the anti-ESG push. While Texas and Florida have jumped into the anti-ESG rhetoric for political gain at their constituents’ expense, Indiana has reviewed the impending financial risk and is taking stock.
There is a bill in the Indiana State House (HB1008) to mandate Indiana’s public pension system divest from investment firms that use ESG. According to a fiscal analysis, this would cost the Indiana Public Retirement System (IPRS) a drop in estimated annual return on investment from 6.25% to 5.05%, or $6.7 billion, over the next decade.
That’s not an insignificant amount. My question is, will the pensioners hire lawyers to protect their investments from politicians? If so, we might see a strong narrative play out in court, which is where this appears to be heading.
In the end, it may turn out that lawyers will be the ones reaping the benefits of the confusion around ESG.