Economy & Business
ESG - Don't kill it by over-measuring it
ESG (Environmental, Social, Governance) principles are all about demonstrating how well companies act in the public interest. But standardising the measurement and reporting of ESG is a nightmare and could make us lose the big picture.
By Lee Faulkner
The spirit or mood of the period of history we are living in now - our "zeitgeist" - seems very firmly to be about companies demonstrating and proving their worth as good corporate citizens. Increasing debate about climate change, and the social justice of supply chains, are undoubtedly boosting interest in ESG, and most people would see that as a good thing. The evolution of our zeitgeist, however, could very well fall into the hands of corporate reporting standard-setters if we let it, and that would be a tragedy. Constantly reminding ourselves that ESG should be about the public interest might prevent that happening.
What is ESG?
ESG is about measuring and judging how well companies behave towards their stakeholders - employees, customers, suppliers, and the communities in which they operate. It covers the whole range of corporate behaviour, for example:
- The environmental impact of its activities;
- Responsible supply chain management;
- Acting ethically;
- Diversity and Inclusion policies;
- Caring for the disadvantaged.
On some big companies' websites "ESG" appears now as a separate tab; on others you can find such policies under "corporate governance" or "sustainability" or "corporate social responsibility (CSR)". Given the huge range and diversity of the companies that most capitalist economies are comprised of, the scope of what could potentially come under ESG is almost endless, and therein lies one of its problems.
What is "the public interest"?
Most people intuitively have a feeling about whether something is or isn't in the public interest; however, most of us would probably struggle to define the concept succinctly. My personal definition is whether a company is treating its customers fairly by taking advantage of an asymmetry of information, that is from knowing more than the customer does; this neatly covers people being ripped off, or being sold something that they clearly don't need and can't afford. But that's just my view.
The charter of my professional body requires me "to act, at all times, in the public interest", but it doesn't define what that means and it leaves it up to the individual to use their judgement and act accordingly. For professionals the public interest is perhaps easier to define as we only have to take personal, not corporate responsibility for what we do. For corporations it's much more complex, and the temptation to use bland "motherhood and apple pie" tropes such as "being a good corporate citizen" or "acting in the best interest of customers" is overwhelming.
I believe that as well as articulating what its core values are, each company should also define what "in the public interest" means for them - successful ESG implementation should then easily follow on from that.
Measuring the success of ESG
The measurement of ESG has taken on a life of its own, fuelled by the adoption of inane mantras from business schools like "only manage what you can measure". And I am not being flippant - by focusing only on what you can measure you completely lose sight of why you're measuring it.
The number of metrics, or Key Performance Indicators (KPIs) that companies need to quantify to measure ESG is potentially vast; some common examples are:
- Environmental: Greenhouse gas emissions, water consumption, energy use.
- Social: Employee satisfaction, supplier diversity, customer satisfaction.
- Governance: Board diversity, executive compensation, ethical practices.
Some of these are clearly measuring inputs, not outputs or impacts - inputs are meaningless unless compared with the inputs for other, similar companies. Some are clearly reactive: is something "ethical" merely because there haven't been any complaints that the practice might be unethical? Many companies' ESG policies are very woolly or wholly aspirational, making the measurement of them almost impossible.
What I haven't seen anywhere (although I'm sure it must have been done somewhere) is a clear referencing of ESG back to the public interest.
Reporting ESG: Voluntary or mandatory?
Most ESG reporting has, thus far, been voluntary, with a plethora of different standards to measure yourself against. There is, however, a trend to move from voluntary to mandatory. For example, a new International Sustainability Standards Board (ISSB) has been set up by the International Financial Reporting Standards (IFRS) board to "deliver a comprehensive global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with information about companies' sustainability-related risks and opportunities to help them make informed decisions". There is a clear expectation that ESG reporting will become compulsory and connected to financial statements. To do that will require the standardisation of benchmarks across geographies and across industries - a massive undertaking.
Standardisation could kill the purpose and make it tickbox-y
The problem with setting standards is that they are always perceived as being unfair to someone, and the more you attempt to deal with inherent or perceived unfairnesses the more complicated and inherently unwieldy the standards become. In my own field, financial reporting for insurance companies, reporting standards go through various exposure drafts, comments, draft implementations, reviews, tweakings, full implementations and further tweakings. The whole process can take years, if not decades, and some companies still complain of being perceived unfairly. That will happen with ESG, but many times worse, and reporting will take on a life of its own, this time on steroids.
The other major problem with ESG reporting becoming compulsory and standardised is that it will become more tickbox-y and perfunctory. That seems to be the history of "compliance" everywhere - well-intentioned principles to protect consumers become exercises in checking that you've done things, rather than whether doing that thing was necessary or even useful. Compliance box ticking is the demon of our age - huge numbers of people work in compliance now, but consumer mis-selling scandals, fraud, limited accessibility, and so on, seem only to get worse not better.
When compliance becomes tickbox-y the whole point of having ESG standards - acting in the public interest - gets lost.
So what should we do?
The measurement of ESG does have a place, notwithstanding the difficulties standardisation will present. I very much doubt, though, that the ESG reporting we end up doing will be read by anyone outside the investor community, and I very much doubt it will be read by the people who are directly affected by ESG and have a right to be informed - the stakeholders.
Real engagement with stakeholders on ESG can only be achieved by a combination of some reporting, active citizenry and corporate openness. In democracies and open societies, there already exist a lot of pressure and action groups on the main ESG areas I listed before - environment, supply chain, ethics, diversity and accessibility to services - what corporations need to do is allow themselves to be challenged by these groups rather than solely relying on an ESG scoreboard of KPIs to do that job for them. That will require a very big change in corporate culture for many companies.
As an example, in the financial sector, the sector I know best, I can think of the following ESG-related pressure points that companies should be flinging their doors open to discuss with their stakeholders:
- Investment policies - how do you define "ethical", how should you measure it (other than as the opposite of "unethical"), and why are there so few options available for customers who want to invest ethically?
- Accessibility - why are bank accounts so difficult to obtain for some people, and all because of non-sensical "risk management" rules?
- Why is buying through an agent the only way to buy insurance in Taiwan?
- Despite being the only country in Asia to allow gay marriage, why are so few senior directors publicly out as gay?
- Why don't senior directors set up meetings with their customers to hear their complaints (and their rants) rather than issuing ubiquitous and tedious electronic customer surveys that very few bother filling out any more?
I could go on (stop me someone, please - I'm on a roll!) but you get my point. If a company was really genuine about ESG then opening itself up to the real enforcers of ESG - the active citizenry, not ESG KPI-setters - would be the ideal way to ensure the company never lost sight of the public interest.
Conclusions
Interest in ESG is growing, and that is a good thing, but we mustn't let ourselves get bogged down in the measurement of it. We all need to spend more time thinking about the public interest as that is the "big picture" that ESG is all about. Companies need a clearer idea of what ordinary people want and should have the right to expect, and our communities and stakeholders are the best way of keeping them in check. Doing that will require companies to really engage, not just go through the motions or issuing scorecards. I am optimistic that real engagement will grow, but we'll need to dial down the reporting a bit to give it a chance.
Lee Faulkner is a Fellow of the Institute and Faculty of Actuaries, the UK's actuarial body, and has more than 30 years' experience in the world of financial services in Asia, Europe and Latin America. He is a Taiwan Gold Card holder and now lives in Taipei.
