Money and Meaning: Fit for Purpose?

ESG is necessary but insufficient. The IPCC “code red for humanity” report delivered an expected but still major jolt to the global financial community. Now, the question is, how should global finance respond to the report’s urgent recommendations? Is the widely adopted ESG approach the best way to successfully mitigate carbon emissions according to Paris Agreement goals?

For an answer, we could start by looking at it through the lens of “fit for purpose,” a British term. In essence, is something working for the purpose for which it was created?

That’s the question posed by Felicia Jackson, in “We need to talk about ESG…Is it fit for purpose?” a Forbes op-ed. Jackson is a lecturer on energy, climate policy and finance at the University of London, and a founder of The Net Imperative Ltd. and New Energy Finance. She acknowledges that ESG matters because “ESG principles frequently underpin what we understand as sustainable investment.” But there’s a problem. ESG can create a “risk profile” of an investment but doesn’t “tell us anything about the impact on overall emissions, pollution, water use or society and the environment.” While noting that ESG “can help cut costs significantly… the question is how far an ESG rating can take you… Becoming ESG aligned, carbon-neutral or even committing to net zero doesn’t tell us whether the company’s strategy is aligned with the Paris goals to keep global emissions reductions within the carbon budget.”

The biggest stumbling block, says Jackson, echoing a familiar refrain, is multiple standards: “The range of reporting methodologies and the lack of standardization and comparability between companies and sectors” that make measuring performance against concrete targets within near-term timelines too various to be useful.

She notes that “many companies report through the Global Reporting Initiative or Sustainability Accounting Standards Board, now merging with the International Integrated Reporting Council into the Value Reporting Foundation” but that few companies report their Scope 3 emissions — the emissions caused by the use of their products and services during their lifetime and disposal. It’s a significant omission from reporting. Without specific targets, actionable time-frames and robust reporting, it’s hard for investors to confirm progress on climate-related issues.

Verdantix, a research and advisory firm, has taken on the dilemma by putting together a new report in which it evaluates the evaluators. Smart Innovators: Climate & ESG Financial Markets Solutions delivers what it describes as “a comprehensive benchmark covering the capabilities” of 45 providers of ESG information, analytics, ratings and data. The report rightly notes that there are multiple ESGs and that the concept is a methodology, not a product, so of course, there will be various versions. Verdantix urges heads of ESG at financial firms to use the report to guide their choice of ESG solutions.

An industry-led initiative by the Partnership for Carbon Accounting Financials is working to develop a “standardized, robust, and clear way for banks, asset managers and asset owners to measure and report the GHG emissions impact of their loans and investment portfolios.” Since November 2020, when the organization launched the Global GHG Accounting and Reporting Standard for the Financial Industry, it has grown to 146 members around the globe representing more than $47 trillion in total assets. Originally a European-driven effort, PCAF has recently been joined by Japanese financial firms Mitsubishi UFJ Financial Group and Mizuho Financial Group.

In another development that underlines the sense of growing urgency in the financial sector to take action, the U.K. has announced the launch of a G7 Impact Taskforce to promote investment with positive environmental and social impacts worldwide. Members of the taskforce, funded by the U.K. as president of the G7 this year, reportedly with sizable industry contributions, have just been announced –– and read like a who’s who of the industry, starting with BlackRock, Temasek and Amundi.

Among the Taskforce’s primary objectives: “to oversee the development of thematic and technical efforts focusing on the need for greater simplification and harmonization of impact reporting methodologies and accounting.” This initiative is being coordinated by the Global Steering Group for Impact Investment, working with the Impact Investing Institute of the UK.

Some investors aren’t waiting. In the wake of the IPCC report, a renewed sense of urgency is driving action and innovation. “As much as the report from the IPCC is bleak and depressing, there is also a call to arms,” says Oliver Haill, a financial journalist, writing in Proactive Investor (another U.K. outfit). “If urgent and large-scale changes are made, then some of the most severe impacts can be avoided and many will be reversible.”