Is ESG enough to stop climate change? What are alternative strategies to create positive environmental change through investments?
Before learning about ESG, I did not like the idea of investing. To me, the act of investing intrudes and, at times, is resistive against the efforts to mitigate climate change by enforcing companies to be responsible for the environmental damage their sourcing, production, and logistics line caused. This is because I thought investing is most concerned about generating a return. However, after learning about ESG and how such rating and investment strategy can be aligned to my own climate activism, it is clear to me that through investing, I have another mechanism to support the movement to stop climate change.
As a quick recap, ESG stands for environmental, social, and governance. It is these three main factors that rating companies can evaluate a company's operation and performance to identify whether the company is socially conscious and is generating positive benefits to society. Nevertheless, the ratings based on ESG have multitudes of nuance, whether it is the lack of standardization that comes from self-reported or the large scope of size, geographic, and industry sector biases. And it is this inaccurate representation of a company's ESG goals and trajectory that can present an inaccurate evaluation of a company and mislead investors. In addition to the problems within the rating system itself, an important question that arises is: Is ESG enough to help stop climate change? As one of the core factors of ESG is the environment, does the shift to companies that have lower energy consumption, water waste, and, but not limited to, depletion of natural resources cause an efficient enough method to stop the pace of warming that would reach 1.5 celsius by 2040?
Although many companies are focused on the "E" in ESG in order to boost their ratings and increase investor fundings to diverge their production emissions, it is crucial that the social and governance side also gets equal attention. It is not enough to just focus on the environment. The "S" should not just amount to stakeholder relations or the issues surrounding unjust production such as forced labor, but it should also be about the welfare of employees and supporting institutions that can provide better living spaces for communities where the companies operate. This is because financial security for the employees and improvement of livelihoods for the community allows for more awareness of climate change and more environmentally-and-cost-friendly alternatives for people to access (such as safer and energy-efficient public transportation). At the same time, the "G" isn't just about the governance of the company but also the relationship the company has with the "External" governance, such as the regulations and policies, laws, and public officials. Investors should not just transition to a tech company instead of an oil company as many tech companies such as Amazon try to reduce their tax, fight against unions, and make multiple local businesses lose their share of the market. Not only does it create an adverse environmental impact in terms of logistics since goods that can be purchased within walking distance must now be delivered, but it also leads to monopolies on markets that influence government policies that benefit the business side of the companies while allowing detrimental effects to climate change they cause to be left unchecked. Thus, it is clear that while the "E" factor is important to reduce and slow down climate change, its impact is not even enough without "S" and "G" that can truly make a difference.
Are there better alternative strategies to address climate change than the current ESG ratings from all the challenges presented above? The first alternative is through the SRI or socially responsible investing mechanism. This investment strategy uses ESG factors to analyze the companies and actively selects investments according to specific ethical guidelines set by the investors and not just fully relying on the ESG ratings. For example, a company with AAA ratings for ESG could not be invested in because the company is involved in labor violations or engage in plastic pollution, which are issues that are against the investor's values. This is because ESG ratings are only based on what the companies make public for the evaluators to see, which may allow them to hide some specific operation details that can degrade their ESG ratings. Thus, while ESG ratings are a good starting point for SRI investors, many take a step further to validate the lack of environmental and social damage the companies claim to make and not just rely on the ESG ratings for their investment decisions. Another alternative is switching to GSE by having companies help develop and comply with the new governance systems that respect governmental institutions and keep in track with the set government environmental goals (such as the Paris Agreement), creating a check-and-balance system between the private and public enterprises.
In conclusion, although the current ESG rating is not perfect and does little to improve the climate trajectory we are currently in, through implementing changes to how ESG should be addressed and looking for new, more effective strategies, investing could be a great help to mitigate climate change.