Over recent months there has been a growing stream of criticism directed at ESG. This is welcome and a vital part of its evolution to becoming an important investment and corporate discipline. However, the critics have created some confusion by suggesting that there is a decline in the relevance of ESG at a time when senior management teams are working hard to embed it into their business models.

The basis of the criticism has been largely targeted at how the investment industry has adopted and promoted ESG, while also questioning the use and quality of data. It has not been targeted at corporate implementation and the efforts made to embed environmental and social responsibility. To take the perspective of the investment industry’s success, or lack of it, in building and forecasting the relevance of ESG factors into their models, and to link this to a decline in relevance, is wrong. The capital markets are just one part of the ESG universe. We undertook research last year into the status of ESG within UK companies and it made clear that ESG is not just a capital markets issue. One of the key findings was that while companies felt significant pressure from providers of capital to implement ESG, this was balanced by pressure from customers, consumers, the supply chain, society, and regulators to name a few. Management teams are increasingly developing their ESG programmes to attract and retain talent; to meet customer and consumer demands; to satisfy pressure from across their supply chain; and/or to build and differentiate their brand and reputation. Many of the positive actions taken by companies are to maintain or earn their licence to operate, recognising that ESG is as much a protector and driver of social value as it is of enterprise value.

It is the difficulty in measuring and benchmarking ESG’s influence as a non-financial risk and value driver that is creating the difficulty. We have acknowledged the challenge of properly measuring ESG for a long time, as it is an area that requires continual improvement if data collection and reporting are to become more correlated to performance and remove the threat of greenwashing – by both investors and corporates. This is only natural for a relatively young and developing discipline and there are considerable efforts to achieve this by organisations such as the International Sustainability Standards Board (ISSB). However, as investors and companies look more closely at the importance of environmental, social and governance factors, there is greater recognition that ESG is a very complex issue. More in-depth analysis of the particular drivers of ESG is required to identify how it strengthens resilience and drives value creation.

Much of our work is in supporting corporates, and other organisations, to understand the drivers and value effects of ESG, using more of a due diligence methodology to analyse a company’s ESG programme. This blends both quantitative and qualitative approaches as well as taking into account the priorities and material interests of wider stakeholders. The influence of ESG differs for every company and the correlation to financial performance and value will vary depending on the approach taken by the management team, how well it is embedded throughout the organisation, as well as other external factors. These social, environmental, governance and economic externalities for each company will also change over time and need to be updated. As a result, we do not believe that a purely quantitative scoring system is going to be able to capture these sensitivities on its own. Our views are shared by corporates. Our same research last year also found that the biggest frustration and challenge for senior management teams was the vast difference in data demands and approaches taken by investors, proxy agencies and rating agencies. For corporates, the impression is that too often the ratings and investment community hide behind a “tick box” approach and are not engaging beyond the data to understand the sensitivities of ESG which are unique to each organisation. Only a few weeks ago, the Financial Conduct Authority published a public warning against ESG benchmarking. This is just one of the many steps that need to be taken to improve ESG analysis.

Criticism of ESG must continue and improving the measurement of ESG is vital. But management teams must not be allowed to think that ESG is an investment fad in decline due to data challenges. The influence of ESG to a company’s performance and value is only going to increase as climate and social challenges continue to grow and have a greater impact – even during these times of margin and inflationary pressure. Any delay in companies embedding these into their business models will be a step in the wrong direction and have potential valuation effects in the future.