Markets

ESG - A Market in Transition

September 20, 2022
5 minutes

ESG has been under intense scrutiny recently. Over the past month, there has been a loud effort to slow down the momentum behind broad ESG adoption. As proponents of ESG, it is important that we understand where those frustrations are coming from and continue to do the work needed to ensure that the transition to a more sustainable economy continues to push on. 

While we are still in the infancy of ESG, the intricate and non-standardized ways to evaluate and communicate performance have led to the overly complicated and murky state that exists today.

The confusion is real and based on today’s reality, but there are better days coming soon. 

First, let’s take a step back. ESG exists today primarily as a way for investors to bring in financially material non-financial data into the investment decision. Now let’s briefly acknowledge that sustainability and impact are different but adjacent topics:

Sustainability is the work a company does to ensure the long-term viability of the business, including ESG work. Impact is the direct and indirect impact a company’s operations have on the communities it operates and touches.

In a perfect world, ESG is the right tool to measure long-term sustainability from a financial perspective. But even in that idyllic state, it doesn’t incorporate impact - this is the reason why a company like Tesla doesn’t score highly on ESG by default. Today, the system is not perfect. Not only is there confusion around the difference between impact, sustainability, and ESG, but there is also an imperfect ESG ecosystem being thrust into the spotlight out of necessity (see huge ESG AUM). 

Let’s take a look at the current state of ESG and what is causing these challenges. At the core, what we are experiencing is what happens when free-market dynamics shift on their own. Consumers care about sustainability, investors care about long-term sustained growth, and employees want to work for more sustainable companies. All of this has led to a fundamental shift in the priorities and values of businesses globally, which is rippling through markets now (bear market aside). 

Today, the main shortcomings of ESG that drive this imperfect system are:

1) ESG disclosures are still guided by non-uniform frameworks and standards. While each is important in its own regard, there are still many different methods companies can use to disclose ESG data- SASB, GRI, TCFD, and CDP are all used by a critical mass of companies today. 

2) Poor ESG data quality is a parasite in the ecosystem. Companies don’t have strong internal data governance to understand and act on their ESG performance. Nor do companies have the ability to measure data anywhere close to real-time. You can’t change what you can’t (effectively) measure (in a timely manner). 

3) Rating agencies are shots in the dark because of the two points above.

This creates a world where companies have difficulty creating and validating the data that ultimately goes into their annual ESG disclosures, that data is often low-quality and non-standardized. Then all of that not-so-great data is fed into advanced rating systems that generate wildly varying results. 

What is being done to counteract this?

  1. Clarify what we mean by impact. Either ignore impact altogether in ESG, and clearly articulate this, or incorporate impact as another factor in ESG. Many would advocate separating impact entirely as that keeps the mission and values of both clear and focused. Part of the problem is that the rating agencies try to fit every company into a simple box scoring system, and when you do that you have a mix of impact and non-impact related ESG scores. When the data is more complete, dependable, and comparable, rating agencies will improve in quality. 
  2. Disclosure frameworks need to be uniform, auditable, and comparable. This work is ongoing with the ISSB, the SEC, the VRF(SASB), and the IAASB. 
  3. Companies need high levels of confidence in their ESG data. This starts with better data sources, and then strong data collection governance. 

Caesar helps with the latter of the two by providing companies with an enterprise-grade ESG data management platform that provides efficient, audit-ready, and defensible ESG data collection processes.

Good data is the backbone of good ESG, and it is lacking today. The result is unsurprising. 

Companies and investors are completely aware of the fact that their end consumers care about long-term sustainability, whether that be a 401k account holder or a consumer at the nearest supermarket, and ESG has been thrust to center stage as a way to somehow measure all of that. 

Regulation aside, investors are going to continue to demand more ESG data from companies. Regulation serves to protect consumers and investors from imperfect information. Caesar’s mission is to provide companies with the tools and resources they need to produce high-quality ESG data with ease.

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