More than one shade of green?

ESG (Environmental, Social, Governance) encompasses 3 areas in which many companies want to improve. In recent years ESG has become a buzzword, making (myself at least) feel as though I am doing “good” when buying from or investing into said companies. However, are these ESG companies as good as we are led to believe?

ESG Integration

ESG is a very broad term, it requires companies to implement many changes to their standard business models. For example; decreasing CO2 production, paying workers appropriately and creating a diverse work force. These examples seem like obvious and important changes to a company’s operations. But for textile companies, who are renowned for low wages in developing countries, and for oil companies, where CO2 production is a by-product of operations, the changes required present immense challenges.

This is by no means a new issue. BP has set its sights on net zero carbon by 2050. This seems ambitious, especially for an oil company, however, it is a good long-term strategy to ensure they can keep up with the gradual change to green energy. ExxonMobil on the other hand, has decided to continue only offering oil and gas products. This was one factor causing the 40% price drop of ExxonMobil shares in 2020.

The cost for a company the size of BP to implement such changes to their operations will be large. Here, I have only discussed their net-zero carbon emissions. This does not include changes required, for example, to address their societal impact or business ethics, both of which will have a price-tag attached. It is expected that in the long-term, the reputational impact of not implementing changes will be far greater than the short-term balance sheet hit.

Climate-related disclosures

Premium FTSE listed companies have to disclose many of their climate-related risks. But a key issue surrounding ESG is the lack of any clear standards. This means it can be difficult for many to understand a company’s climate disclosures and differences compared to others. Also, this makes ESG standards for companies more difficult – whether they are doing enough, more than enough or not enough can be hard to distinguish.

The complexities surrounding ESG reporting may be one reason for the different standards of ESG compliance - sometimes called the “multiple shades of green” - within ESG funds. Fund managers and analysts will thoroughly research a company before purchasing, but there are no clear standards for funds as to what constitutes an ESG investment. The lack of standards for companies and for funds, means that it is up to the fund’s subjective opinion on what constitutes ESG and what will make up their ESG portfolios. This can lead to differing opinions on whether companies are ESG and varying ESG ratings for the same company across funds.

In my opinion this has generated confusion surrounding the term ESG. ExxonMobil is included within the S&P500 ESG index, even though it has no plans to reduce its oil and gas offering. The S&P has backed the ESG allocation, saying the index is for those who integrate core ESG factors into their investments. Companies can also outsource parts of their supply chain, to hide potential ESG related risks from their disclosures. These and other nuances result in disparity between ESG funds.

Concluding remarks

It is commonly said that ESG funds provide superior returns for investors compared to non-ESG funds. But whether that will be in the near-term or in the long-term has not yet been proven. Further to this, we do not know whether these superior returns will be from companies with stringent ESG policies (e.g. impact initiatives) or those that loosely follow ESG guidance.

According to Morgan Stanley, 85% of investors are interested in ESG investing. This number is only set to rise as consumers become more aware of ESG’s importance. As such, it is important that clear rules regarding ESG standards are put in place, to allow a simple understanding of which companies are doing well and which need to do more. As more companies embrace the ESG title, it is important that we can understand whether a company is green, and importantly, what shade of green it is.