What is ESG?

The term ESG was first used in a 2004 UN report with the title ‘Who cares wins.‘

After the economic collapse of 2009, marketers were looking for a new buzzword to sell, ESG was a golden opportunity. 2010 was a period of a zero-interest rate environment, which further aided in the rise of ESG. Its rapid rise and evolving nature generate significant debates regarding its effectiveness, implementation, and impact.

Common ground:
The scope of the analysis will be a capitalist market.

At this stage, there are two popular principles that we must understand

1. Shareholder Primacy / Single Materiality: The Corporation's sole responsibility is to maximize profits for its shareholders

2. Stakeholder Primacy / Double Materiality: Corporations must consider their entire supply chain and stakeholders.

ESG, at some level, aims to reconcile the two principles and provide a framework that takes the middle path.

The Case Against ESG:

• Lack of standardization: When the UN first termed ESG, it was very confined. However, with time + popularity, the term has expanded to encompass everything, and now it means nothing.
  
  Everyone seems to have their own definition of ESG and methods of calculating ESG scores.
  
  For instance, a few ESG-focused investment funds have the thesis of investing in firms that will gain the most from an ESG focus. Based on this thesis, they invest in Chevron a leader in the petroleum and fossil fuel industry, notorious for their emissions. Rationalizing that Chevron is positioned to gain the most from a shift toward greener alternatives.
  

• Greenwashing: Closely related to the lack of standardization is the risk of greenwashing—where companies misrepresent their environmental efforts to appear more sustainable than they are. This practice undermines the credibility of ESG metrics and can mislead consumers and investors.
  
  Carbon credit and the associated metrics can be criticized along this tangent. Shell, a leader in the oil and gas industry, has run questionable carbon offset campaigns, which are facing growing criticism.
  
  Let’s examine the Cordillera Azul project in Peru and the Katingan Peatland project in Indonesia by Shell. Both projects claim to protect forests and generate carbon credits, however, upon closer inspection, it is evident that the ‘protected forests‘ were not economically valuable in the first place. The claim of generating carbon credits by prevention of deforestation falters. (Full-length video)
  

• Questionable Motives: We must ask ourselves, ‘Who are the proponents of ESG?’.
  
  China is a strong advocate for ESG. Zoom out, and you realize China has a virtual monopoly on lithium, a key material for EV batteries. It is in China’s interest to promote ESG and establish its monopoly over the EV space. In this case, ESG comes at the cost of national security.
  
  Apple has fantastic ESG scores today; these scores, however, were built on the back of slave labor in a different country. Apple has a trillion dollars and is inching toward a monopoly. ESG can and has been used by large corporations to pull the ladder out from behind so that no one can get there. Emerging ventures can not afford the cost of complying with and adhering to ESG regulations, hence stifling innovation and creating a more monopolistic market.
  

• Questionable Value: Today, half of the Public Benefit Corporations (a type of corporation with ESG at its core principle) on the US stock market have tanked by 60% since their IPO. Does this mean that investors backed unworthy and fundamentally weak firms to go public, or that predatory firms used derivative greenwashing to capitalize on people's goodwill? In either case, the negative impact is undeniable.

The Case For ESG:

• Relativity: Most of the cases against ESG employ a myopic view and dissect what has happened in the past, present, and near future. The impact of ESG is pronounced in the long run.
  
  Despite potential short-term costs, ESG criteria can enhance long-term sustainability and profitability. Companies that adopt sustainable practices tend to be more innovative and adaptive to changing environmental and social landscapes, reducing risks and opening new markets. Good finance and ESG are two sides of the same coin. (https://www.youtube.com/watch?v=-ennpQf0bBU&ab_channel=INSEAD)
  

• Improved Risk Management: ESG metrics provide critical insights into non-financial risks, such as environmental disasters, social unrest, or governance failures. These insights help companies mitigate risks before they escalate into crises, safeguarding both the company and its investors.
  
  Corporations that take a holistic approach to risk assessments ensure that an industry can withstand adversities. They take a step to ensure that the industry and the value created by the industry can continue.
  

• Driving Change: Large corporations that harm aspects of ESG in their current operations require capital to change their trajectory. Chevron's receipt of funds from ESG investment vehicles indicates a step towards a greener future, one that, with the influx of funds, it can achieve without compromising its position in the market.
  
  Furthermore, we gain more from pushing large organizations toward an ESG-first approach as they utilize a component of their own funds to experiment with ESG and are poised to have an impact greater than an amalgamation of smaller firms. Furthermore, their success will set a precedent and provide new entrants with replicable strategies.
  

• Improved Regulatory Compliance and Fewer Legal Risks: Companies committed to strong ESG principles are typically ahead of the curve when it comes to compliance with new environmental, social, and governance regulations.
  
  This proactive stance can significantly reduce the risk of legal issues, fines, and sanctions, which can be costly and damage a company’s reputation.