Is ESG a scam?
With rising temperatures – and not only because of summer hitting the northern hemisphere – “ESG” is increasingly becoming a hot topic. The economies of the world need to become greener, more responsible and sustainable, and “ESG” is one of the related buzzwords. But the debate is also heating up: Last month Elon Musk tweeted that “ESG is a scam”. And even though Musk is sometimes too trigger happy on Twitter, this statement should be taken seriously. Maybe more business leaders should support it - or maybe more should defend “ESG”. Before we can start this discussion we first need to agree on what we mean by “ESG”.
“ESG” is short for Environment, Social and Governance. That is two nouns and one adjective in a combination which does not really make much sense – something seems missing. I recommend everyone who talk about “ESG” to start adding a word after this acronym. Not only as it will be grammatically better, more importantly it is likely to reduce confusion and misunderstandings.
I was first introduced with the term “ESG” when I joined the impact investment fund Norfund in 2010. Long before it became hot and trendy, ESG Due Diligence was key part of the assessment of potential investment cases for the fund. After investment was done, ESG reporting from the portfolio companies was central for our follow up of their development. Norfund invests in companies the world’s least developed countries, and naturally there was a lot of ESG risk related to their operations. We did not look for perfect companies, but part of our role as an active impact investor was to ensure they would improve on ESG management.
Twelve years later I am based in China. The Chinese government is stepping up to the challenge of sustainable development and climate change, and awareness of these issues is rising among Chinese companies. “ESG” has become a buzzword also here. However, I mostly hear the term in very different investment circles than what I knew in Norfund. Here it is used mainly related to passive stock market investors. The dominating idea is that there is a potential to beat the market by selecting investment targets with good ESG ratings. Coupled with the extreme technology optimism in China, numerous service providers offering digital solutions to ESG analysis have entered the market. Any available data points available, be it in national pollution registers, media or annual reports, are analyzed to create ESG investment indexes.
These two examples shows the importance of adding at least one word to ESG to have a constructive discussion. From operational standpoint, or as an active and involved investor, one should talk about ESG management and ESG reporting. With new regulations on non-financial reporting being implemented in the EU, US as well as China, this is increasingly relevant for all types of companies. It is no longer a marketing issue or for special purpose companies such as Norfund. If you are talking about ESG data analytics and index development it is something quite different. However, ESG data analyst should be following the reporting standards and requirements closely, as well and understand the practices by the listed companies. Or else the acronym GIGO becomes all to relevant: Garbage in -Garbage out.
Now back to Elon Musk’s Tweet: The background was that Tesla was removed from an ESG index. For many, it might sound very strange for a company which has been instrumental to the global shift towards electric vehicles for the benefit of the Environment. However, anyone who knows how the indexes work will not have been surprised. First of all E, S and G are quite equally weighted. If you treat your workers badly, i.e. get a low S score, that is not outweighed by a good E vision. Further, the E rating is not so much about carbon emissions from your products in use. It is more about those from your production, as well as other pollutants, and your plans to reduce these. And of course, owner behavior which can pose risk to the long term business is a negative for the G score. An example could be running investor relations over Twitter.
So is “ESG” a scam? If your financial advisor sells you an ESG index as an investment strategy to support the most innovative businesses for a carbon free future, it definitively is. If your boss tells you she does not believe that ESG management can improve the company’s non-financial performance, she is scamming you.
Your English teacher could have pointed to the same: How can “Environment, Social and Governance” be a scam?
Picture from a Taobao village. Rural development has been a major development impact of Alibaba Group, also recognised by the UN and others.