The problem with ESG
ESG is a subject which we have regarded favourably over the years, believing, as we do, in a holistic approach to corporate governance, which takes account of the interests of wider stakeholder groups.
However, ESG has developed a life and existence of its own, which is creating problems and awakening opposition from different directions. A recent example prompts us to write this article.
Stuart Kirk, head of responsible investment at HSBC, participating in an FT Moral Money discussion forum earlier this year, expressed personal opinions about what he considered extremist pressures on people like him from bodies such as climate change groups, which triggered a strong rebuttal from his boss, and resulted in his resignation. As the face of HSBC, he was probably asking for trouble, but in the context of the FT Moral Money discussion forum, arguably he should have been allowed to put a contrarian point of view.
In a subsequent opinion piece in the FT, Kirk brought out what he considered to be fundamental flaws in what people regard as ESG. In brief, what he was arguing was that there were what he called ESG ‘input’ investors and ESG ‘output’ investors. It appeared that for him, ‘input’ investors simply regard ESG as one of the risks of investment; for ‘output’ investors, the ethical or green or sustainable output from their investments is what matters.
Hence, he said, while being a personal supporter of ESG, in his view ESG, as currently understood, was fundamentally flawed and ought to be split in two.
We sympathise with the views he expresses, and agree with the inconsistencies he highlights, but from our perspective, he approaches the issue far too narrowly. So, in this article, we examine ESG and seek to put Stuart Kirk’s criticisms and proposed solutions in a wider context.
Our interest is in holistic corporate governance, which, for us, means the way the Board conducts itself to guide the company to achieve its agreed Goal. If we consider ESG in this context, it has a coherent purpose, and addresses Stuart Kirk’s fundamental concerns.
Assessing a company’s success
Since ESG is a critique of a company, first let’s ask: how do we assess whether a company is successful? The answer is: it is successful if it is achieving its declared Goal, which is the primary responsibility of the Board. It would be generally expected that the way in which this Goal has been achieved would be compatible with and acceptable to local customs and ethics.
How do we measure whether the company is, indeed, achieving its agreed Goal? Our holistic approach requires that:
- the Goal is one agreed by all key stakeholders and the company has an ethical approach which matches the expectations of the key stakeholders
- the measurement process is agreed by all key stakeholders
- measurement itself involves getting the views of the key stakeholders, and the results are transparent and not subject to organisational capture.
- Compliance with:
- the company’s constitution
- laws of the land
- regulations of particular industries
- Compliance with our Five Golden Rules of holistic good Corporate Governance:
- an Ethical approach
- a Goal agreed by all key stakeholders
- a viable Strategy to achieve the Goal
- an Organisation resourced and structured to deliver
- Accountability and transparency of reporting back to stakeholders
- Measurement of performance by asking key stakeholder groups
- Ensuring that weighting of stakeholders is up to date
- ie do assumptions about the relative importance of various stakeholder groups to the company’s future still hold (and hence the importance and relevance of their views)
- if not, how should the Goal or Strategy be modified
Where does ESG fit in?
What is ESG?
ESG can broadly be described as an attempt to get companies to better meet the requirements of society at large.
How do you measure it?
One of the problems is that there are no internationally agreed answers to this question. However, in brief, and taking the three elements in turn:
- E: Environment
- Environmental performance is assessed by comparison with various current concerns, eg climate change, and the positive or negative effect the company is having locally and globally
- S: Social
- Social performance is assessed by comparison with local and global standards of treating employees
- G: Governance
- Governance performance is assessed largely by judging a company’s compliance with local Corporate Governance Codes
To a large extent, ESG performance is compiled from information published by the company concerned, not by the rigorous procedures our holistic CG demands.
Who is it for?
On the face of it, ESG monitoring is:
- for the benefit of investors who are concerned about these things
- to help protect employees
- to help protect wider stakeholder groups who may be affected by the company’s activities.
How well does it do it?
- the big problem is that no reliable, generally accepted measures of ESG currently exist, though there are plenty of different ones being used
- misleadingly, there is general acceptance that a high score (however derived) leads to good performance.
Key issues arising
So, regarding ESG, the following key issues would appear to arise:
What is the point of ESG reporting?
ESG reporting, at least in the eyes of the investment world, and probably those of the large public corporates, is all related to responsible investing
- that is: the perspective looking at it from the investor’s point of view…
- …and not concerned with the company per se as an independent entity, except from the point of view of an owner
As an integrated concept it doesn’t make sense
- corporate governance is about holistically directing the company to its agreed Goal, but in ESG terms, G is essentially just about compliance with corporate governance codes per se
- E is taking account of the wider stakeholder group (the World)
- S is addressing employees and local communities
You can’t integrate all these in any meaningful way, except as a series of boxes ticked, even from the (limited) point of view of the investor
What should the Board do about ESG
- from the Company Board viewpoint, ESG should be part of good Corporate Governance (as in our Five Golden Rules)
- if the stakeholders don’t like the Goal or the Strategy and the ethical approach to get there, they shouldn’t, respectively:
- be a customer
- be an employee
- supply goods or services
- provide finance
- give local permission to conduct operations
- give national permission to operate legally
ESG as it’s currently being rolled out by monitoring organisations or regulators, will NOT work satisfactorily due to:
- incoherent goals, described above
- a generally accepted lack of widely agreed measures,
- confused purpose: the conclusion from the arguments above
It is becoming an investment guide, but it shouldn’t dictate company policy, which should be about achieving the agreed corporate Goal.