“Is it the end of the ESG market?” a student asked me this week. Elon Musk’s emphatic criticism of ESG ratings, police searches of a Deutsche Bank unit on suspicion of greenwashing, criticism by influential US senators Marco Rubio and Mitt Romney of excessive moralizing in the corporate market, authorization of the Swedish giant SEB (known for being a sustainability leader) for their funds to invest in companies in the military sector, or the denialism of the global responsible for responsible investments at HSBC, led many people to ask the same question as my student.
The ESG agenda has never been consensual, there have always been those who cast doubt on the financial viability of sustainability, but this agenda has never been so publicly criticized as it has been in recent weeks.
Many of these criticisms reveal a lack of knowledge of what corporate sustainability or sustainable finance is. Others mask corporate or individual interests. But it must be recognized that, in essence, many of them are valid.
The ESG market has expanded at an adolescent pace in recent years. But the exponential evolution of the volume of assets under management that apply environmental, social and governance lenses, the almost universalization of managers and banks that adopt sustainability practices, or the unusual pressure from the media, were based on very fragile foundations.
ESG, capitalism’s greatest innovation of the last century, has grown in a disorganized way, without structured planning, adequate regulation or supporting services infrastructure. For the ESG market to become more resilient, several initiatives must be implemented.
ESG rating agencies need to be regulated. The ESG market is largely based on the ability of managers and banks to integrate data to more accurately measure the risks to which their portfolios are exposed.
Some managers are also interested in measuring the impact (positive or negative) of their investments. Qualitative and quantitative data are the lifeblood of the sustainability market. Who provides this data? More than 100 rating agencies that operate in a deregulated and non-transparent regime. Criticisms abound to the methodology of these agencies and their materiality analyses, reflected in the low correlation between the final grades.
Organizations such as Iosco (International Securities Organization) and the American, French and Dutch regulators have warned of the limitations of these agencies. Some of them even offer consulting and data services at the same time, a practice seen as irregular and long banned, for example, in the traditional audit market.
The trend is that in some years there will be only four or five of these agencies. S&P, Moody’s, and Fitch are expected to buy the ESG rating agencies and incorporate them into their own credit ratings. At the same time, some agencies that measure the impact of companies’ products and services will survive. But national and international regulators should also extend their actions to this market. And quickly.
What is an ESG Fund? Nobody knows. There are financial products created to align with moral values (not investing, for example, in arms or tobacco companies) or to intentionally generate positive social or environmental impact. But for the most part, funds integrate ESG practices, data and policies with the aim of identifying new financial risks and unlocking value creation opportunities. This tripartite division is not, however, consensual or hardened. There is room for flexibility. And it is from this flexibility that greenwashing and impunity spring.
Therefore, it is critical that regulators adopt legal criteria to determine what an ESG fund is. We have to go far beyond good practice guides.
Anbima (Brazilian Association of Financial and Capital Market Entities), at the end of last year, was the first, worldwide, to take a step in this direction with the application of prerequisites for a fund to be considered “sustainable”. or that “integrates ESG issues”.
In the UK, US and UAE regulators are preparing similar measures. But we need to accelerate the pace and have global leadership in this regard. The market has the disease diagnosed, knows which drugs to prescribe, but has been hesitant to treat it.
Finally, we have to standardize the companies’ reporting. When a Brazilian corporation (or one from more than 140 countries) reports its financial data, it only uses a universal model –IFRS. But the reporting of the work of the same company in the area of sustainability can be based on more than 30 different standards, as complementary as they are conflicting. This multiplicity affects data quality and comparability between companies. Furthermore, when sustainability reports are not audited, it is fertile ground for greenwashing.
Fortunately, many of these standards are in an accelerated process of merging and, in the coming years, companies will be expected to use the global disclosure standard that is being developed by the ISSB (International Sustainability Standards Board), announced at COP26 in 2021.
None of these problems or solutions attempt to address any conceptual problem regarding the financial viability or moral relevance of sustainable finance or corporate sustainability. At its genesis, ESG remains an essential instrument for generating financial, social and environmental value. But the ecosystem that allows its growth needs to be shored up. It is on this front that we should focus our attention in the coming years.
I have over 8 years of experience in the news industry. I have worked for various news websites and have also written for a few news agencies. I mostly cover healthcare news, but I am also interested in other topics such as politics, business, and entertainment. In my free time, I enjoy writing fiction and spending time with my family and friends.
