ESG disputes beyond the backlash
09 June 2022
ESG under scrutiny
Anyone who follows the world of "ESG" will have noticed a theme in the commentary over the past few weeks. Leading financial publications have run pieces with titles like "How ESG investing came to a reckoning" and "ESG exposed in a world of changing priorities" (the Financial Times), "The ESG Backlash" (Bloomberg), and "The Pushback on E.S.G. Investing" (The New York Times).
The inspirations for this are various. The world's largest asset manager announced that it intended to vote in favour of fewer environmental and social shareholder proposals in 2022, than it had previously. Comments by a senior banking executive, questioning the financial risk arising from climate change were widely reported, as were remarks by Elon Musk, CEO of Tesla Inc., to the effect that ESG – as a concept – was "a sham".
Headline-grabbing as these interventions are, there are more fundamental reasons for confusion over the value of the ESG label. The acronym has always encompassed a mixture of different concepts. Almost everyone would say that climate change mitigation lies at the heart of ESG. But other components of the term are harder to define and measure, for example when you consider the "S" (social) and the "G" (governance) of ESG.
The invasion of Ukraine has highlighted some of the tensions within the notion of ESG, as governments struggle to balance their ambitions for decarbonisation with short term concerns about energy security and fuel poverty. Some ESG investors are questioning long held tenets of ESG investing: faced with war on European soil, does it remain the right thing to do to direct capital away from defence companies producing the armaments to resist military aggression? What about fossil fuel companies developing gas reserves in the North Sea and Africa, weakening Russia's relative strength as a hydrocarbons exporter?
The tensions inherent in ESG
In reality, these tensions have always existed within the evaluation of sustainable business activities. Take the renewable energy sector. Renewables have a great story to tell from the decarbonisation perspective, but have faced their own challenges when it comes to the mining of vital components, and are also getting attention as to how they are produced, including the social and human costs of projects. Transition away from fossil fuels is becoming widely accepted in the developed "north", but raises questions about "just transition" – how the benefits, and burdens, of the quest for net zero are allocated globally. (COP26 in Glasgow produced a goal of at least USD 100 billion in climate finance per year, in part to facilitate the transition from fossil fuels to green technology, but questions remain about the timing of contributions).
What about ESG disputes? Clearly the tensions described above can generate their own class of controversies and litigations. This is inherent in any situation where parties have unclear, and potentially divergent, understandings and expectations. In the last few weeks there is evidence that authorities are increasing their scrutiny of green or sustainable products. It would not be a surprise to see claims emerge from allegations that supposedly ESG-friendly products or services promote one aspect of ESG, while neglecting others.
What next?
It has been suggested in some of the recent commentary that it is time to retire the "ESG label". Perhaps a better course would be to recognize its complexities, and the complexities of similar terms such as "sustainability" or "responsible investing". "ESG" creates a keyword that gets us thinking, talking and acting on issues which have not had a place at the table. But no one term can capture the multifaceted nature of today's world, nor the competing priorities at play within ESG. They are only ever signposts to a more nuanced conversation about what matters, and what society, and the actors within it, think is most important.
From the disputes perspective, this approach to ESG can only serve to mitigate risk. If companies are transparent and honest about what they mean when they talk about ESG, and how they are implementing this, the prospect of claims for misstatement or breach of duty of care reduces.
It might be argued that ESG itself was a backlash against a model for business which prioritized shareholder returns over the environment and human wellbeing. Evaluating companies through an ESG lens is a recognition that a single metric - shareholder dividends or revenue - is insufficient to create long term value. Today's backlash against the backlash can usher forth a more sustainable era for ESG, where the term is unpacked, clarified and used to promote informed choices and aligned expectations going forward.
Author: Tom Cummins (Partner).
