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Why ESG is under fire and yet will only become more important

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The current concept of ESG has immanent flaws

The rising criticism of ESG – mostly directed at ESG as an integrated concept in the investment context – is not unfounded. The term captures an enormous breadth of themes, many of which are not directly related (as the frequently cited example of Tesla’s exclusion from an ESG index on grounds of its weak governance performance shows) or even stand in contrast.

In addition, many environmental, social and governance impacts are inherently difficult to measure and rank, this is precisely why it is so difficult to achieve robust and commonly accepted standards”. Also, there is no common understanding of what financial market actors mean by ESG and what outcome they want to achieve with it. Is ESG “just” about risk management? Or is it indeed about a real-world impact?

Against the backdrop of yet another period of extreme weather events around the world and despite a perceivable short-term shift of political priorities as a reaction to the Russian war in Ukraine: it is important to underscore that the criticism mostly targets ESG as a concept and term, rather than the general idea of ESG disclosure, measures or even climate action as such.

But the underlying rationale continues to carry enormous momentum

There is no way around it: business and financial actors must enable a transition to net zero. And this expectation will carry more and more weight due to a number of drivers: expanded ESG transparency and reporting requirements, evolving regulatory standards shifting the market and competitive environment, investor demands, and societal pressure.

With regulation such as the EU Taxonomy and the introduction of mandatory non-financial reporting disclosure requirements for over 50.000 companies, the EU is keen to create a blueprint for the first net zero continent. Its regulation on supply chain due diligence will markedly boost the relevance of “S” and “G” factors. In the US, the long-awaited proposed SEC rules on climate transparency aim at making corporate climate impact more transparent.

Lastly, corporates have an intrinsic motivation to up their ESG game and there is more and more evidence of this. Superiority on business relevant ESG criteria tends to drive economic impact and correlates with higher valuation vs. peers and (moderately) lower cost of capital .

In an increasingly polarized debate, corporates need to develop a strong ESG proposition while being transparent about its impact and trade-offs

The ideological debate on ESG will continue and might even intensify, especially in the US. At the same time, a lack of common standards and reliable ESG data to measure and evaluate companies’ ESG performance creates more confusion. The result is a complex environment where true commitment is difficult to prove and greenwashing allegations can severely damage companies’ reputations. The best advice to navigate this challenging environment is to focus on

  • a. identifying the material risk factors and value drivers on the relevant ESG dimensions,

  • b. building ambitious ESG strategies with credible targets material to the company and integrated into corporate strategies and business models,

  • c. explaining how ESG strategies are being implemented, highlighting the complexities of the net zero transformation, and being candid about trade-offs,

  • d. communicating ESG roadmaps that provide transparency on commitments, concrete action and tangible progress, showing that targets are not an end in itself.

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