As someone working on business sustainability for a bit shy of two decades, the increased use of the term ESG has always puzzled me. And it seems to have replaced Sustainability and TBL (Triple Bottom-line), that classic and elegantly simple sustainability framework propounded by John Elkington who I, like many others, consider as my sustainability guru.
I can understand that Environment (the E of ESG) and Social (the S) issues impact business success, and this will only increase. And Governance always mattered, and its new-found importance is strange. But why the three of them are spoken in the same breath is a bit baffling to me.
E & S are crucial for business success
E&S are inextricably intertwined, which is well recognised by the familiar Venn diagram of TBL. That any action, including by business, on the environment has significant social consequences is evident; for instance, GHG emissions cause global warming and hence climate change, one of the consequences of which is extreme weather conditions which in turn impacts food production resulting in loss of livelihoods, lower nutrition and hunger. Water pollution causes innumerable diseases and reduced availability of potable water with its health and livelihood impacts. Air pollution hugely impacts human health as any denizen of Delhi will testify. The impacts of mining and land acquisition to build factories and their effect on lives and livelihoods is an ongoing tragedy from time immemorial. Sadly, the adverse impacts of environmental destruction on the poor are completely disproportionate to their role in causing it.
Conversely, social challenges also impact the environment. As land gets scarce, with acquisition for factories, mines and wildlife reserves, the landless and the displaced have little choice but to occupy forest land and clear them for agriculture, potentially impacting biodiversity and forests. Poverty, malnutrition and poor education contribute to population increases which in turn increases the pressure on natural ecosystems. Non-existent sanitation facilities in places where the poor stay results in sewage entering river systems. Inequality is both the cause and effect of this deterioration in environmental and social resources.
G matters but is artificially attached to E & S
I also agree that how a company is governed has a huge impact on its success, and in the way it manages E&S impacts and challenges. But that still does not explain the logic of clubbing Governance with E&S when the typical indicators of governance – executive compensation, related party transactions, minority shareholder treatment – have little impact on E&S. And in rating a company’s sustainability performance, what is the logic of the weightages of these 3 parameters adding up to 100?
To understand this, I looked at the 2004 publication called “Who Cares Wins”, where the term ESG was apparently first used. Authored by financial institutions at the invitation of the then UN Secretary General Kofi Annan and the UN Global Compact (UNGC), the report essentially aimed to “develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions”. That is when the penny dropped for me.
It was a result of a belated realisation by the financial services sector that their investment decision frameworks, which were based purely on financials, were incomplete, because a host of non-financial parameters were playing a game-changing role. Top amongst these were Environment, Social and Governance or ESG.
Thus, the common thread stringing ESG together is not the logic of inter-connectivity but merely the fact that all 3 are non-financial – united by the absence of the financial. Since the all-powerful financial sector coined ESG to deal with its own process shortcomings, that became the accepted terminology, showing the door to the more holistic idea of Sustainability. And so my quest for the logic of these terms being clubbed was futile because it was, at best, weak.
The way forward
So what is the way forward? For me, there are two. First, the actions, and hence the indicators, that get classified under Governance need to be expanded and more nuanced. And two, while the E&S performance of a company may be assessed and scored together as these are interrelated, the Governance performance of a company needs to be assessed separately. In other words, if these must be scored, there needs to be a separate E&S score and a G score. Let me expand on these.
Expand the G parameters
As mentioned earlier, Governance frameworks typically measure company performance in terms of parameters such as board competency and skillsets, board and committee independence, related-party transactions, minority shareholder treatment, executive compensation and so on. These are all important and provide crucial insights on how a company governs itself and goes beyond compliance.
However, in a world where E&S factors increasingly impact business success, these metrics seem incomplete. There is a strong case to be made for understanding how a company’s governance structures provide oversight on E&S risks and performance, the need for a sustainability strategy, sustainability disclosures and so on, which traditional governance frameworks do not cover. If ESG as a term is too embedded, then it should be the latter set of parameters that should be included in such frameworks, with the traditional “G” metrics being assessed independently.
Assess G separately from E&S
Since E&S are logically related, it makes sense to assess them together. The logic for this will become stronger as assessments and measurements move from performance (as it is now) to impact (which is the future). Governance indicators must be expanded (as argued above) and measured separately. Investment Committees must get out of the comfort zone of a single, convenient but less meaningful, ESG assessment to a more nuanced and accurate assessment where E&S and G are assessed separately.
In an increasingly complex world, where the environment and society can no longer be sacrificed at the altar of economics, the inconvenience of two scores instead of one is a small price to pay.
Shankar Venkateswaran is the Co-Founder and Managing Partner-Sustainability Integration at ECube Investment Advisors Pvt. Ltd. He has worked extensively on corporate sustainability and has been involved in various policy initiatives with the Ministry of Corporate Affairs, Government of India and teaches Sustainability in management schools.
