GARY RYNHART: Linking ESG closer to UN’s sustainable development goals can reduce cynicism

A recent special report on environmental, social & governance (ESG) investing by The Economist magazine was largely dismissive. In a nutshell, the main editorial argued that ESG is a complex set of often overlapping and contradictory issues that are beyond most firms. Business should stick to just the E part, it argued, specifically E for emissions.

I agree these are complex and overlapping issues, but to dismiss ESG completely is wrong-headed. It is perhaps the speed with which ESG investing has grown that has resulted in complexity and cynicism.

ESG ratings are inconsistent and can be contradictory, policing is scant, greenwashing rife and commercial self-interest conflates true motives, as fees for ESG investments are mostly higher than standard investing practices. But this does not mean it will go away or pivot to an environmental focus.

Large companies struggle with a soup of acronyms and competing reporting frameworks. That should get easier with efforts by the International Sustainability Standards Board to make nonfinancial disclosure more consistent. On the other hand, smaller firms think ESG is not relevant for them. They are wrong. Legislative requirements in more and more jurisdictions place ESG oversight obligations across the supply chain. Put simply, if you are a supplier to a firm in one of these jurisdictions those rules apply to you.

ESG starts with compliance and works its way up from there. Companies must comply with the law on social issues (everything from labour laws to discrimination and health and safety), on environment (reducing carbon emissions, waste management) and on governance (corporate governance, corruption, bribery). This is the law. Any companies not complaint are breaking the law.

Going beyond compliance presents opportunity but also risk, and this is where many companies come undone, often by being strong in one area of ESG but exposed in another. For example, a firm promotes its low emissions rates, but has contracted staff on low rates of pay in suboptimal safety conditions. 

The scope for misstep is large, but if companies focus on four things they can navigate these complex waters: ensure legal compliance; meet ESG assurance obligations from suppliers or customers; identify your main exposure to reputational risk and avoid looking at risk or opportunity through a narrow binary lens; and do not falsely overstate your ESG actions, which can result in legal action. More jurisdictions are giving teeth to laws in this area.

There is strong potential for ESG to drive wider socioeconomic development goals, but that’s not happening now. ESG funds remain largely concentrated in rich countries. Most “sustainable assets” are invested in Europe and North America. Less than a quarter is invested in Asia, Africa, the Middle East and South America combined. Why? Most investors view African markets as risky, citing market constraints, low-quality governance, corruption, lack of liquidity or other market constraints. 

The African reality is marked by the dominance of extractive industries, high exposure to climate change and pressing developmental needs. Yet there are more opportunities in Africa for investors to make a positive environmental or social impact than in any other region in the world.  This will require more innovation and imagination. For example, investors could accept disclosures that meet local best practices instead of imposing their own standards, and by understanding local realities. 

To achieve this will require greater interaction between financial institutions, UN agencies and other development actors that can lead to better understanding and increased transparency. In particular, the UN’s Sustainable Stock Exchanges Initiative, which supports flows of finance to developing country markets by improving ESG disclosure in these markets, can be an important player. Sixteen African stock exchanges are now members of this initiative.

Connecting the “SDG development agenda” to the wider ESG agenda in significant bespoke ways could be a game-changer and reduce less cynicism about the industry.

• Rynhart is senior specialist in employer activities with the International Labour Organisation, based in SA.