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Why at this particular moment is ESG investing generating so much controversy?
ESG investing considers the costs and risks associated with environmental, social or governance concerns that can materially affect a business. It has exploded in the past decade.
Now, after a boom, ESG investing is facing hard scrutiny. Several U.S. states have proposed or even passed anti-ESG legislation. While attention has grown, there has been an intense political backlash.
In Indiana, the debate about ESG has garnered attention and turned the investment world into a battleground. Nationally, President Joe Biden last month used the first veto of his presidency to halt anti-ESG legislation.
Unfortunately, much of the anti-ESG debate is shrouded in confusion. Supporters of ESG concepts maintain that considering environmental and social risks is part of an investment manager’s obligation to maximize future returns. Moreover, ESG supporters argue that considering future business risks, such as costs from pollution, is consistent with market principles and confers benefits to shareholders.
The Indiana Bankers Association and the Indiana Chamber of Commerce oppose anti-ESG legislation, calling it “anti-free market” because it excludes some institutions with ESGs.
However, anti-ESG groups maintain that these concepts might hurt businesses like coal companies and firearm makers. Critics also argue that ESG investing lacks consistent measurement standards and oversight.
But these anti-ESG critiques do not fully consider recent progress in ESG investing.
This leads to the obvious question: Why is ESG investing so poorly understood?
One possibility is that many decision-makers fail to distinguish ESG investing from two related concepts—socially responsible and impact investing. Socially responsible investing and impact investing refer to the intention to generate positive, measurable social and environmental impact alongside a financial return. ESG investing, unlike socially responsible investing, does not require targeting a range of returns from below market to market rate, depending on investors’ strategic goals.
Notwithstanding the confusion, there are three reasons to expect ESG and other forms of responsible investing to grow despite the current backlash.
First, ESG frameworks are gaining global recognition and becoming more transparent. More than 600 agencies now operate within the ESG rating landscape. The flow of information to investors and managers can strengthen the overall ESG landscape. Rating providers are improving their methods by including factors such as the materiality or relevance of ESG goals to business goals.
In the future, there will likely be more standardization, clarity and consensus on measuring the environmental, social and governance variables and the weights provided within the ESG context.
Second, there has been progress regarding oversight and regulation in ESG work. As the field develops, greater oversight, transparency and consensus will become even more critical.
Third, the volatile social and political environment has created more urgency for investors to assess ESG factors. Some scholars have argued that specific ESG variables will allow companies to navigate the climate and political risk necessary to function in uncertain times.
With changing market conditions, including ESG analysis alongside traditional financial variables might broaden our understanding of risk. For ESG investing to achieve its full potential, however, we will need to push for greater transparency and reliable data.
We must prioritize high-quality information and actions that improve our planet and allow future generations to thrive.•
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Osili is professor of economics and associate dean for research and international programs at Indiana University Lilly Family School of Philanthropy. Send comments to ibjedit@ibj.com.
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