ESG — one score does not fit all

As highlighted in the recently published Sanlam-Business Day ESG Barometer, an increasing number of SA companies are recognising the value of sound environmental, social and corporate governance (ESG) performance to attract capital and talent.

By integrating material ESG considerations into a company’s ethos and operations a sense of pride and commitment can be cultivated among employees, customers, shareholders and suppliers. To achieve a virtuous circle of sustainable wealth creation, it is important for companies to not only engage in positive initiatives but also to disclose their ESG performance truthfully.

Managing material ESG risks has become so important that some JSE-listed companies are now linking executive remuneration to the achievement of ESG targets. Others are linking their finance costs to ESG performance. Gold Fields provides a case in point. If it meets its 2030 ESG targets it will pay lower interest rates on loans.

Not only are more companies reporting on their ESG activities, but the depth and breadth of disclosure has improved in recent years. These positive developments and a growing demand for standardised data have led to data providers computing comprehensive ESG scores. Key players in the field include Morgan Stanley Capital International (MSCI), Thomson Reuters, Bloomberg, S&P Global and Krutham (formerly Intellidex).

While some of these scores only rate how truthfully or transparently companies disclose their ESG activities, others consider disclosure and the nature of the ESG activities and initiatives undertaken.

There is much definitional ambiguity regarding the term “ESG performance”. The distinction between reporting and performance is important, as reporting and disclosure are not tantamount to performance. ESG disclosure also differs from corporate social responsibility (CSR) disclosure as the latter typically excludes environmental considerations.

Positive light

Many companies engage in greenwashing, in which a corporate report provides a false impression of a company’s efforts to address climate change and other environmental ills. It also includes actions to deceive the public about how eco-friendly (and ESG-friendly) a company’s operations and products and services are.

Whereas some data providers incorporate public controversies in their score computations, most rely on self-reported company data (or disclosure). In the absence of formal ESG reporting guidelines more emphasis is placed on those policies and activities that portray the company in a positive light, such as donations, and efforts to reduce its carbon footprint and enhance diversity. The company may also neglect to report on, or understate, harmful impacts and negative externalities such as pollution or unfair labour practices.

Companies’ selective disclosure of only positive ESG initiatives lowers the validity of reporting. Neglecting to fully disclose all ESG activities, positive and negative, has consequences for various stakeholders, particularly investors who assess ESG considerations when making investment decisions. In an attempt to combat greenwashing and improve the reliability of disclosure, the JSE published best practice guidelines on sustainability and climate disclosure in 2022.

Reliable ESG scores are indispensable investment tools as financial markets increasingly embrace the notion of sustainable prosperity. However, investors should ensure that the scores they use for JSE-listed companies should cover a broad spectrum of considerations, as environmental and social considerations are inextricably linked. For example, a company pumping untreated effluent into a river not only contributes to water pollution (environmental) but also adversely affects the livelihoods of downstream communities and farmers who depend on the water for irrigation (social).

False progress

Investors interested in locally listed companies should also note that context-specific social criteria, such as the promotion of broad-based BEE and youth employment, are seldom included in generic ESG scores. As noted in the Sanlam-Business Day ESG Barometer, SA has different ESG priorities compared with more developed countries, with economic growth and inequality featuring more prominently in the local context.

The prolific American journalist Sydney J Harris once said: “The greatest enemy of progress is not stagnation but false progress.” Mindful of this advice, investors should ensure that their data provider not only considers reporting, but also assesses ESG performance relative to legislative requirements, industry standards and voluntary targets. More comprehensive ESG scores should reduce some of the reputational risks posed by greenwashing, thus reflecting a more accurate representation of a company’s overall performance.

The bigger picture of true ESG performance will enable investors to make more informed investment decisions, especially when considering a company’s progress on material ESG risks over time. It is only by insisting on transparent and truthful reporting that ESG investors will bring about real change.

• Hickman is a master’s student, and De Vries and Viviers academics, in the business management department at Stellenbosch University. They write in their personal capacities.