A new report says that ESG faces a “make or break” moment, with a lack of standardization, regulation and common purpose—and concerns about “greenwashing”—threatening trust.
Environmental, social and governance (ESG) investing and reporting is facing existential questions associated with a lack of standardization, regulation and common purpose, according to The emerging sustainability information ecosystem, a new report published by the EY organization and Oxford Analytica. The authors note that rising inflation and the war in Ukraine are compounding these challenges.
According to the report, growing allegations of greenwashing have become one of the major challenges to ESG credibility and success. The authors argue that addressing these challenges and building trust in the system is the responsibility of the many players who shape the sustainability ecosystem if ESG is to be seen by stakeholders as on a par with the more established ecosystem of financial reporting.
The report acknowledges that there has been a lack of agreement on what ESG should include, how to apply agreed metrics, and how best to use available data. To build greater trust in ESG, the report outlines five core areas that its authors say must be addressed:
- Increased transparency over ESG ratings. The report’s authors argue that current ESG ratings do not serve investors interested in social impact as they are weighted on financial materiality. “For those interested in financial risk management, a lack of transparency over the weighting of ESG topics reduces clarity and decision-usefulness.”
- Increased understanding of the varying uses of sustainability information. The report notes that the two primary uses of sustainability information are to assess financial risk and social impact—but explains that these “are not mutually exclusive but are easily confused.”
- Independent assurance alongside enhanced reporting standards and rigor, similar to financial reporting. The report notes that the rise of independent assurance — coupled with enhanced standards and increased automation and reporting rigor—has the potential to further build trust in sustainability information and among ecosystem actors.
- The development of agreed sustainable finance taxonomies to help eliminate confusion on what is considered sustainable and what is not. The report argues that sustainability “taxonomies” (systems designed by jurisdictions for determining which economic activities should be considered sustainable) founded on complementary principles would boost comparability and transparency across markets while recognizing that markets have different philosophies, legal architectures and economic structures.
- Lower barriers to entry for those from emerging economies. The report claims that emerging economies will account for a large majority of the world’s greenhouse gas emissions by 2050, but have “less resilience to be able to adapt to the impacts of climate change and are located in the areas most likely to be severely affected by climate-related events.” The authors comment that attracting capital to activities that do not just slow climate change but mitigate its consequences is “essential.”
The report concludes that core elements of sustainability information—notably ESG ratings—are expected to face heightened regulator interest and action. “Amid these policy developments, the broader ecosystem will continue to debate the ideal relative roles that actors in the ecosystem play, lessons that can be learned from the financial reporting ecosystem, the continued broadening of the definition of ESG, and how the ecosystem serves investors and other stakeholders focused on financial risk and social impact.”
