ESG alone may not be Enough
As Phillip Morris joins the list of companies on the Dow Jones Sustainability index, increased scrutiny into what ESG is and is not have surfaced
In February 2022, more than $1 trillion in assets representing more than 1,200 funds were stripped of their ESG Tag by Morningstar, Inc.’s classification system. The reason given by Morningstar’s Hortense Bioy, global head of sustainability research, is the “funds that say they consider ESG factors in the investment process, but that don’t integrate them in a determinative way for their investment selection.”
While Morningstar was culling it’s ratings, MSCI’s (the company that indexes companies into indexes) also announced it’s stance that they will consider the actual record a company has on impacting climate change versus merely how transparent the company is about its own operations. The combined shift in the investment world holds lessons for all organizations, especially those with investors.
Impact investors are leading that shift. The Global Impact Investing Network defines “impact investments” as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.” These are investors who are not looking so much at what a company did internally but rather what is the impact that company is making externally.
Let’s break that down a bit….
ESG tends to focus on operationally what the organization did in the past. It is a rear-looking “report” that looks at internal issues such as diversity and inclusion, energy consumption, and governance. It is an essential look at what the company did, but not necessarily into what the company is doing and the external effects of the organization’s product or service.
ESG also tends to look at avoiding harm or minimizing risk versus contributing towards solutions and positively benefiting stakeholders to sustain long-term financial performance.
You might think about it like this, ESG is a set of criteria focused on the environmental, social, and governance factors that will have a material financial impact on the company. An important set of factors to consider, but what they do not do is reveal what that company is actually doing to solve the climate crisis or otherwise positive external social and/or environmental impacts of the organization.
The recent emphasis on what organizations are doing underscores the reason for this shift. I believe we tend to think that perhaps ESG is a bit broader than it actually is. If you want to understand how the company looks at itself internally from a financial perspective, then we are looking at ESG factors. But if we look at how an organization is driving measurable positive change outside of the company, we turn to impact factors. While both are important, one is not inclusive of the other, and in fact, they are both necessary to have a well-rounded Sustainability Program. This can be highlighted in the frameworks that have emerged and really highlight the difference between organizations that are motivated by doing no harm versus organizations that are focused on benefiting stakeholders:
It is crucial for organizations to understand the importance of using ESG and Impact together, providing a comprehensive strategy that is a data-driven approach to measuring operational improvement efforts. Such an approach benefits internal and external stakeholders while accounting for relevant risks and opportunities. This may be challenging, particularly if the organization doesn’t have the resources to dedicate to this more comprehensive approach. In those cases, conducting a materiality assessment of both business and stakeholder interests can be critical in ensuring that resources are aligned with what is material to the business.
The following table can help organizations prioritize when prioritizing ESG and Impact on the development of strategy:
When an organization is focused on not only minimizing risk but also on prioritizing its ability to positively impact externally, those concerns about the failure to integrate sustainability factors begin to fade. This provides access to the growing number of investors who want to see their money go towards stocks or funds that are both profitable and reflective of their social values.
Both ESG investing and impact investing have critical roles to play in addressing the world's many systemic challenges, and we need to direct more capital toward both. To attract that investment, we need more organizations to engage their ESG opportunity seekers to take stakeholder considerations into account. We need organizations focused on being diverse with inclusive teams, engaged employees, and reduced environmental footprints. Such organizations will be well placed to lead transformations of legacy industries and can create remarkable benefits for society.
Portions of this blog post were inspired by Mark Segal’s article, ESG and Impact - Why We Need Both for Meaningful Change as well as:
The World May Be Better Off Without ESG Investing
ESG Investing Needs to Expand Its Definition of Materiality
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Chris Laughman is the ThirtyNine Blog author, a blog dedicated to reducing the impact of the built environment. When not blogging, Chris is helping the real estate industry minimize energy and water impact as the Vice President of Sustainability for Conservice, the Utility Experts. Whether Multifamily, Single Family, Student Housing, Commercial, or Military, we simplify utility billing and expense management by doing it for you. Our insight into your utility consumption provides an opportunity to identify risks. Leveraging innovation and experience, we ignite solutions with real impacts and track performance to ensure the trendline stays laser-focused on the goal. At Conservice, we have developed a true bill-to-boardroom solution to help truly make a difference. We have before us a tremendous opportunity. Standing shoulder to shoulder, we will get this done. Contact me at claughman@conservice.com for more information.
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