Environmental, Social and Governance (ESG) approaches have fundamentally restructured financial investment over the past 20 years. However, the effectiveness of ESG approaches is difficult to measure, hampered by a lack of strict, regulated, and unifying disclosure framework. Accusations of ‘greenwashing’ – claiming an ESG approach without any meaningful action, have become more frequent.
The proliferation and complexity of ESG reporting has led to a
lack of auditing practices, comparability, and trustworthiness in ESG
disclosures. Despite more companies
claiming ESG approaches, global emissions and social inequity are rising. So
are ESG approaches even working? How can we measure their effectiveness?
What are ESG Approaches?
ESG approaches are business and investment strategies that
factor environmental considerations such as decarbonisation, social
considerations such as labour rights, workplace standards, safety and
diversity, and governance considerations such as transparency and minority
shareholder rights.

The ESG concept was coined in 2004 by the UN Secretary and the
UN Global Compact in the Who Cares Wins initiative and endorsed by 23
financial institutions collectively representing over US$6 trillion in assets.
Since 2004, ESG assets have grown sharply, reflecting the increased investment
into decarbonisation, social and governance outcomes. ESG assets have grown 30%
annually for the past five years and totalled US$35 trillion in 2020. At a 15%
growth rate, ESG assets will exceed US$50 trillion by 2050 – a third of total
global assets under management.

Europe has traditionally comprised most of the world’s ESG
assets; in 2016, the region held US$12 billion in ESG assets, 52% of global
assets. However, the United States has been rapidly increasing its ESG assets
over the past five years; its share in ESG assets was US$17 billion in 2020,
48% of global assets. Europe’s share has remained stable, while Canada,
Australia and Japan have increased their assets.
Environmental Considerations
Environmental considerations within ESG approaches include CO2
emissions (Scope 1 and 2), waste produced, energy used, and water withdrawn.
Environmental considerations have increased corporations’
understanding of climate change as a risk and opportunity, environmental
innovation and emission reduction.
They have also influenced investor
behaviour; a study performed by the Harvard Business Review across 43 global
institutional investing firms found that ESG concerns are a priority for
investors, with environmental performance being the most frequently raised
issue.
The value of environmental concerns in investment has been validated by
the consistent outperformance of companies with high environmental ratings over
companies with low ratings.
Environmental considerations for countries and corporations were
reinforced by the 2015 Paris Climate Agreement, that promulgated
decarbonisation, sustainable development and environmental integrity.
Social Considerations
Social considerations within ESG approaches include labour
standards, pay rates, safety, workers’ rights, ethics and corruption,
diversity, equality and inclusion.
The UN’s Sustainable Development Goals outline social
considerations for countries and corporations, including health, education,
equality, employment and social protection. However, there is a lack of
specific, quantitative framework to measure social considerations.
Despite social considerations being directly linked to risk in a
company’s financial performance, investors prioritise both environmental and
governance considerations over social ones – possibly because of the lack of
quantitative measurement framework.
Governance Considerations
Governance considerations within ESG approaches include
transparency and disclosure, minority shareholder rights, board structure,
diversity and effectiveness, codes of conduct and tax strategy.
Governance considerations increase the accountability of
companies, and their ability to respond to stakeholder preferences,
Like both environmental and social considerations, high ratings
on governance considerations have been linked to positive financial
performance.

ESG by Region: Europe
The EU has been the leading proponent of ESG approaches since
2004. In 2005, the EU commenced its Emissions Trading System, which places
national caps on emissions and allows emissions allowances trading.
In 2018, the European Commission published the Financing
Sustainable Growth action plan that created ESG benchmarks and put in place
measures to enhance ESG transparency and disclosure. This aligned with
benchmarks created in the Paris Agreement in 2015.
The Financing Sustainable Growth plan focused on environmental
considerations and set out five objectives: climate change mitigation and
adaptation; the sustainable use and protection of water and marine resources;
the transition to a circular economy; pollution prevention and control; and the
protection and restoration of biodiversity and ecosystems.
Under the Financing Sustainable Growth plan, companies must
disclose ESG factors, allowing benchmarking and a consolidated ESG rating. This
then influences investment decisions.

United States
In 2020, the US had the most ESG assets under management, these
were valued at US$17 billion, and surpassed Europe. The Securities and Exchange
Commission (SEC) sets the US’ disclosure processes and benchmarking.
Environmental disclosures were first set by the SEC in the 1970s and were
updated in 2010 to provide information to investors. In March 2022, the SEC
released an updated Climate Disclosure Rule Proposal, the broadest federally
mandated ESG data disclosure requirement for corporations in the US.
The Climate Disclosure Rule Proposal mandates disclosures on the
oversight and governance of climate-related risks, the impact of climate risks
on finances, outlook or business model, transition plans and climate
strategies, GHG emissions, emissions goals and internal carbon pricing.
The Proposal, despite having extensive mandated environmental
disclosure practices, does not contain practices for social or governance
disclosures. It aims at simplifying disclosure practices for corporations and
enabling investors to incorporate environmental risk into their investment
decisions.
The Proposal has since been subject to public feedback and has
received criticism over its Scope 3 emissions disclosure requirement and its
elimination of the materiality qualifier – whether the disclosure materially
affects the environment – for certain disclosures. It is expected that the
Proposal will face further legal challenges.
Canada
Canada
emerged as the leader in 2020 when it comes to measuring the proportion of
Sustainable Investing, relative to the total assets managed. Canada
currently counts 61.8% of its total assets as Sustainable Investment Assets.
Responsible
Investment Association (RIA) has been collaborating with several other institutions
and organisations to come up with initiatives to promote the transition to a
low carbon economy. However, Canada accounted for 7% of the total Sustainable
Investing Assets, 3.1 trillion Canadian Dollar in value.
The gradual
rollout of mandatory ESG disclosure is coming to Canada in 2024, and so are
legal risks for companies that fail to meet disclosure requirements.
In April 2022, the federal government tabled its latest budget, which included a number
of measures aimed at achieving a net zero economy, as well as a promise to
bring mandatory climate-related reporting requirements to federally regulated
banks and insurance companies.
Beginning
this year, the Office of the Superintendent of Financial Institutions (OSFI)
will consult with banks and insurers on developing climate disclosure
guidelines that adhere to the Task Force on Climate-related Disclosures
framework.
China
In 2016, the People’s Bank of China, the China Security
Regulatory Commission (CSRC) and five other agencies released the Guiding
Opinions on Building a Green Finance System, an incipient environmental
disclosure system.
This was followed by the Cooperation Agreement on Jointly
Developing Environmental Information Disclosure of Listed Companies in 2018,
which formally established the disclosure system. These systems are concomitant
with China’s ambition to reach peak carbon by 2030 and net-zero by 2060.
In 2020, 1,021 Chinese A-share companies published annual ESG
reports, compared to 371 companies in 2009. However, China’s overall ESG
disclosure scores remain low. There is no unified standard for disclosure, and
information disclosed is often incomplete or not credible. As in the US, there
is a lack of social and governance considerations in disclosures.
Japan
Japan increased their ESG assets sixfold between 2016 and 2020,
despite Japan having no regulations that mandates ESG disclosures and
investing. In 2021, the Financial Services Agency of Japan issued the Building
a Financial System that Supports a Sustainable Society report, which called for
greater ESG reporting by companies and for specific ESG regulations to be
mandated.
Japanese companies have invested heavily in decarbonisation;
Japan has pledged to reach net-zero by 2050, and there has been a 40% reduction
in energy intensity of GDP from 1970. Electrification and decarbonisation in
Japan’s power and industry sectors – Japan’s two largest emitting sectors –
will drive Japan’s environmental approach.
However, Japan has low scores for social considerations. Despite
a high level of safety in Japanese companies, extremely long working hours,
inflexible working styles and strict culture make labour conditions poor. There
is also poor gender diversity in Japanese companies, which ranked 121st
out of 153 in the World Economic Forum’s gender-gap rankings. In 2018, the
Japanese Government passed the Work Style Reform Bill to address these issues.
Australia
Like Japan, Australia has no overarching ESG regulation, but
separate disclosure mandates set by commonwealth, state and territory
governments. The National Greenhouse and Energy Reporting Act of 2007 set up
reporting practices for companies, as well as a range of renewable energy and
emission reductions targets.
Australia has consistently lagged on environmental action; in
the 2020 Climate Change Performance Index, Australia ranked last of all 57
participating countries with the worst possible score of 0.0 out of 100.
Australia’s environmental performance may improve following its recent
elections; the new government has already increased its emissions reduction
target to 2030 to 43%, up from 26-28% from the previous government.
43% of ASX200 companies made ESG disclosures reports in 2021 –
an increase from previous years, though still low by international standards.
80 ASX200 companies adopted recommendations from the Task Force on
Climate-Related Financial Disclosures relating to emissions and environmental
impact disclosures.
The Australian Securities and Investments Commission (ASIC)
regulates Australian corporations and financial markets and has made
disclosures on environment and governance approaches a focus for 2022 – without
releasing any specific disclosure mandates.
ESG Effectiveness and Criticism
The financial effectiveness of ESG approaches is validated by
the demonstrated outperformance of companies with high ESG ratings over those
with low ones. However, the environmental and social effectiveness of ESG
approaches is more difficult to measure.
This partially arises from the
difficulty of measuring some ESG factors over others; Scope 1 and 2 emissions,
for example, can be easily quantified and monetised in the form of carbon
prices, but other factors, such as Scope 3 emissions, or impacts on ecosystems,
cannot.
Social and governance factors are likewise hard to quantify; though
studies have shown that diverse and gender-equal management teams make better
decisions, quantifying the effect of diversity is difficult.
Despite a dramatic increase in ESG approaches by companies,
carbon emissions and social inequity have continued to rise. The Harvard
Business Review found that ESG disclosures are often incomplete, imprecise and
misleading – a type of ‘greenwashing’ in which companies claim an ESG approach
without taking meaningful action. This is not helped by the lack of any
regulated and unified disclosure framework.
Auditing practices for ESG
disclosures are almost non-existent; despite many companies producing ESG
reports, very few are validated by third parties. Companies also have
discretion over what ESG disclosure practice to follow.
ESG definitions are
incredibly broad, and factors disclosed vary between regions. The variability
in disclosure practices by companies then creates a lack of comparability that
undermines investor trust in ESG disclosures.
If ESG reporting in developed regions is specious and complex,
then it is almost completely ignored in developing nations – areas such as
India and Africa, in which the largest increase in emissions will come over the
next decade.
The social effectiveness of ESG approaches is also extremely
difficult to measure. A study from the University of Zurich found little
evidence to suggest that ESG approaches make meaningful change for workers or
communities. Instead, the majority of social investing was into funds that stay
away from specific industries – tobacco and weapons – to create ‘social
benefit’.
There are also criticisms that ESG approaches focus on minor ESG
improvements that do not alter the wider business structure – changing the
office lights to LEDs rather than rearranging the value chain of a product.
In order for ESG approaches to be effective, there must be a
paradigm shift from wealth-accrual to environmental and social wellbeing. This
will require a restructuring of the market as a whole – most likely through
public policy. ESG reporting must become simpler, lesser, and unified to allow
greater transparency and avoid ‘greenwashing’.
Environmental targets must be
not only aimed at restricting emissions and impacts, but also at limiting growth
to within nature’s capacities. But given that limiting growth is antithetical
to market competition, ESG approaches may continue to be broadly ineffective
for some time.