Rethinking ESG: Not dead yet!

Climate Economy

Rethinking ESG: Not dead yet!

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Climate capitalism and the sustainability imperative.

This article was updated on June 5, 2023. 

It’s been a bad year for ESG. Attacked from the Right, Left, and Center, the practice of managing companies or investing with an eye to Environment, Social and good Governance has been vilified as everything from a “woke” political agenda, to a superficial and misleading marketing tool, to a convenient way for companies to claim sustainability without actually doing anything. And many of these criticisms are true.

ESG looked close to death in America, until President Biden used his first veto to block a Republican bill barring pension funds from using it, and earlier this month asked a federal judge to throw out a lawsuit filed by 25 GOP-led states, seeking to block the rule. As of mid-June, that case is pending. Meanwhile, 21 GOP-led states accused 53 major asset managers of prioritizing “political goals over financial interests” and ordering them “to choose between their legal duties to focus on financial return, and the policy goals of ESG activists.”

Never mind that ESG is designed to reduce risk and maximize returns, that shareholder maximization is not law, or that ESG funds have tended to perform better over time.

Despite the pushback, ESG has not only survived, it’s thriving: 85% of investment managers and 96% of S&P 500 companies use ESG to mitigate risk, find opportunities, and build profits. Among U.S. institutional investors, 81% plan to increase ESG allocations, boosting more sustainable assets under management 84% by 2026. 

Why? Because ESG is better business. Despite claims to the contrary, long-term data shows that ESG investing has outperformed the overall market, even in 2022 when oil stocks bounced back. An NYU/Rockefeller Asset Management study of more than a thousand research papers found that ESG and climate-focused investments have outperformed.

Despite claims to the contrary, long-term data shows that ESG investing has outperformed the overall market, even in 2022 when oil stocks bounced back.

That said, many critics are right: ESG needs reform. The big ratings agencies tend to rely on a shallow set of unverified self-reported data, and focus on short-term financial risk and shareholder value, without addressing longer term risks – and opportunities. Given rising global demand, ESG ratings will need to provide more fact-based and verified reporting, and deeper analysis of long-term risks and corporate action. 

“Wall Street’s current system for ESG investing is designed almost entirely to maximize shareholder returns, falsely leading many investors to believe their portfolios are doing good for the world,” NYU’s Han Taparia wrote. “For ESG investing to achieve its potential, Wall Street players will have to change their system… More likely, the Securities and Exchange Commission will have to change it for them.” 

Indeed, the SEC is expected this year to finalize rules that would require standardized disclosure of climate-related risks and Scope 1 and 2 emissions. The EU has been adding new reporting standards, while Asia and emerging markets are requiring more, too.

This isn’t just a bunch of censorious ol’regulators imposing red tape. Data shows that most consumers, investors, insurers, and pension funds want more and better ESG, not less. So now nearly all businesses focus on ESG. That would have been unimaginable five years ago.

What’s driving this trend, despite the political pushback?

ESG helps companies make better business choices by anticipating risks from climate change; pollution of our air, water and land; growing inequality, and loss of biodiversity, agricultural productivity and social cohesion. Forces we cannot control – from more extreme weather, rising temperatures and seas, and the growing millions of climate refugees – are already impacting our lives and economies. For a business leader, it would be a rookie mistake to ignore such macro forces. And in an Internet-empowered world, stakeholders know what you are – or are not – doing about the threats they feel. 

Together, these drivers of change have created what we call The Sustainability Imperative: Whether you like it or not, you will become more sustainable.  

Whether we kick and scream or embrace innovation for passion or profit or both, there’s growing recognition that we need to continue changing the ways we do business.

Embracing what is good for you, and not just the visible bottom line, has always been controversial. It took a long time for people to recognize that seat belts save lives, smoking can kill, and burning coal is no longer the best way to power our homes, factories and trains. Whether we kick and scream or embrace innovation for passion or profit or both, there’s growing recognition that we need to continue changing the ways we do business. As Charles Darwin said, a species’ ability to “adapt” is crucial to its survival. 

ESG 2.0: The emergence of natural and regenerative capital 

That word survival isn’t just rhetoric: it’s for real. To avoid environmental and social upheaval, companies must recognize that wealth creation is more than accumulating financial and manufactured capital. To build sustainable wealth, we need to enhance all forms of capital, including natural capital and human capital – and trust.

Natural capital includes resources, but also nature’s “services,” such as absorbing pollution, preserving a stable climate, biodiversity, fertile soils and cleaning the air and water. Nature has provided these services for free, but continuing to lose them will impose huge costs.

The narrow corporate focus on maximizing shareholder value has depleted natural capital. “Estimates show that between 1992 and 2014, produced capital per person doubled, and human capital per person increased by about 13% globally; but the stock of natural capital per person declined by nearly 40%,” The Economics of Biodiversity reported, adding that nature needs to be recognized as a “global portfolio of assets,” just like our other assets. The report called for rebuilding natural capital.

GDP does not compute the cost of $5 trillion in natural destruction per year

The core metric of the Industrial Revolution has been Gross Domestic Product. However, this only measures sales, and has no way to measure the cost and impact of industrial activities on nature, and the long-term impact that already has on the global economy. 

To build sustainable wealth, we need to enhance all forms of capital, including natural capital and human capital – and trust.

The destruction of nature is also absent from traditional balance sheets. A global team of economists found that if we measured the economic cost of these losses, almost no company on earth would be profitable. We are losing almost $5 trillion every year in natural services that intact ecosystems used to give to us, but that because of the impact we’re having on them, are no longer fully functioning. 

Confirming the fundamental economics of supply and demand, as we deplete nature, it provides fewer essential services – and at a higher cost. We can’t just fertilize and pesticide our way out of this.

Perhaps the hardest economic nut to crack is economic and social inequality

Providing a decent life for 8 billion (soon to be 10 billion) people on earth will require a shift to regenerative business practices across all sectors. Without that, scientists estimate, hundreds of millions, and possibly 1.2 billion people, will be driven by climate chaos from their homes by 2050 – more than 1 of every 10 people in the world. (You think we have border problems now?) 

A global team of scientists chaired by Dr. Johan Rockstom assessing human impact, identified nine “planetary boundaries” beyond which nature would no longer operate within its restorative abilities, including greenhouse gas emissions, the ozone layer, pollution, freshwater, and biodiversity.

Oxford Economist Kate Raworth, in her book Doughnut Economics, combined outer planetary boundaries with underlying social boundaries, e.g. access to jobs, education, food, water, health services and energy. If we live within both sets of boundaries, she wrote, humanity can thrive in a “safe and just” space which she illustrated as a donut

Kate Raworth’s Doughnut is a visual framework for sustainable development that combines “planetary boundaries” with “social boundaries.” The center depicts people who lack access to life’s essentials (healthcare, education, equity, energy etc.) The crust represents the ecological ceilings or “planetary boundaries” that life depends on and that humanity risks exceeding. The green donut shows the “safe and just space for humanity.” 

In what she describes as humanity’s early 21st Century “selfie,” Raworth later
updated her donut to reflect scientists’ consensus that we’re exceeding four of our nine planetary boundaries, and that in 12 social dimensions, millions of people are still struggling to fulfill their basic needs. Only by meeting the needs of the world’s ever-growing population, while also valuing and protecting our living planet, can we build an economy that will serve the people and the planet. 

In 2022, scientists determined that humanity was exceeding a fifth planetary boundary by allowing a 50-fold increase since 1950 in the production of chemicals, including plastics: more chemical pollutants than the planet can process. “This is projected to triple again by 2050,” said co-author Patricia Villarubia-Gómez from the Stockholm Resilience Centre. In June, 2023, Rockstrom and other scientists of the Earth Commission reported that humanity has exceeded seven of the nine boundaries.

“Science is showing clearly that we are at risk of destabilising the entire planet and its life support systems,” Rockstrom said.

Leaders see the surveys showing that 91% of global consumers want brands to demonstrate sustainability, 87% want to do more about climate change, and 85% have switched to more sustainable brands.

Exceeding nature’s ability to process humanity’s impact poses an existential risk. It also increases stress on social stability. If we continue, we’ll fail to ensure that everyone on earth can live decently – and therefore have sufficient stake in the system to preserve social cohesion. We’re already seeing how deep economic frustration around the world is fraying the fabric of society. In the U.S., inflation-adjusted income has barely budged since the 1970s. Globally, eight men have as much wealth as the bottom half of humanity.

The business case for a just climate economy

Why should business care? The data is clear: 1. Failure to sustain people and planet risks social and environmental disasters. 2. Restoring greater equity and a healthy environment is better business. 3. It will preserve health, safety, stability and prosperity. 4. It’s the right thing to do. 

Over time, sustainable practices improve profits, as they eliminate waste, toxicity, risks and costs. You profit from innovation in a “circular economy,” in which waste is captured and reused. Circular economy strategies take design inspiration from nature – which, among its other services, provides a 3.8 billion-year-old innovation, iteration and testing laboratory.

These “radical” ideas are difficult for a generation of corporate executives who still believe they live in an Industrial Age. However, as manufacturing declined to 12% of U.S. GDP and 16.7%, we entered the Internet Age. Now we are moving inexorably into a new Climate Age. As with any profound economic change, that requires new ways of thinking. 

The incentives to change are escalating. The investment opportunity of solving these global problems is worth “trillions of dollars,” Harvard Professor Rebecca Henderson says. Oxford Economics estimates it at $10.3 trillion. These are not costs. These are returns on investments. 

Many executives understand this. They’re adopting sustainable practices not for politics but for profit. ESG is moving from the PR department to the CEO’s conference room, where it is increasingly seen as crucial to addressing risks and opportunities. Leaders see the surveys showing that 91% of global consumers want brands to demonstrate sustainability, 87% want to do more about climate change, and 85% have switched to more sustainable brands. In the U.S., where annual consumer spending tops $14 trillion and two thirds of GDP, 59% would boycott companies that don’t act on climate change. More than 75% say social media influences their views or inspires them to act on sustainability. In political parlance, these are landslides.

Besides adding brand value, cutting emissions reduces the costs of the energy that produced those emissions. Nearly 80,000 emission-reducing projects by 190 Fortune 500 companies reporting data showed nearly $3.7 billion in savings. 

If you want to attract and retain the best talent, key to profitability, you will embed ESG in your operations. 

Some 86% of businesses expect sustainability will boost revenue in the next year. Many are designing for better quality, longer life and recycling. When the circular economy was modeled a decade ago, researchers estimated that implementing it would add a trillion dollars to Europe’s annual GDP, and cut three quarters of carbon emissions. Others estimated it could boost global GDP by $25 trillion by 2050. What opponents refuse to recognize is that ESG is an increasingly valuable financial tool, not a social agenda.

The next generation is driving sustainability 

Young people want companies to focus on climate. In surveys, 69% of Gen Z consumers said they feel anxious about the future after seeing climate change reports; 75% said sustainability is more important than brand name. Among GenXers, 67% prefer sustainable companies; 83% of millennials say it’s “extremely or very important” that companies take care of the environment. If you want to attract and retain the best talent, key to profitability, you will embed ESG in your operations. 

Young people want to be engaged. They want a say in business, environmental and social policies. And if businesses are smart, they’ll give them that say. Gallup found an engaged workforce brings up to 24% higher productivity and 21% higher profitability. 

These are just a few of the reasons that businesses working with ESG principles tend to outperform. Critics who say ESG is “woke” have it backwards: ESG is better capitalism, practiced by business leaders who in the U.S. are mostly Republican. And it’s logical: of course you’ll make more money working with – rather than against –  your environment, society and good governance. Whether we like it or not, our global economy is making a transformational shift toward ESG to make sure we survive – and even thrive.

Written by

Hunter Lovins & Barclay Palmer

Hunter Lovins is a pioneer in the global environmental movement. She’s an author of 16 books and hundreds of scientific articles and founder of Natural Capitalism Solutions, Chief Impact Officer of Change Finance and a Managing Partner of Now Partners, Hunter has won dozens of awards, including the Right Livelihood Award. Time recognized her as a Millennium Hero for the Planet; Newsweek called her a Green Business Icon. Her recent book A Finer Future: Creating an Economy in Service to Life won a Nautilus Award. ◼ Barclay Palmer is Senior Editor and Head of Strategy at Climate and Capital. He also serves as strategic advisor in cleantech, media, energy, and edtech, specializing in messaging, fundraising, recruiting and research. Barclay has been an award-winning journalist over 30 years at CNN, CBS News, Bloomberg, Reuters, Newsweek, RealVision, Times Mirror, PBS NewsHour and other outlets. He played senior roles on Amanpour, Anderson Cooper 360, Newsnight, CNN Business News, and in managing coverage of 9/11, TWA Flight 800 and other major events.