ESG is here to stay!

Now is the time to stay the course on ESG, through a strategic and targeted approach, routed in reliable data for clear, meaningful and factual decision-making, writes Martina Macpherson

Geopolitical context and ESG

Geopolitical tensions significantly impact ESG strategies. Conflicts, such as current tariff and trade wars between the US and China, or the US and the EU, are not just a question of sovereignty. They also highlight the importance of human rights, resource and supply chain management, as well as of regulatory balance-checks, global norms, ethics, and conventions – all ultimately critical components of "ESG".

Companies, with global exposures to strategic, operational, reputational, and regulatory risks and externalities, must navigate these ever-growing tensions while maintaining their commitments to profitability, stakeholders, sustainability and corporate governance and controls.

On the investor side, the impact of ESG-focused strategies on portfolio performance has been at the forefront of much the academic and industry literature debate. The focus of many studies has been traditionally on the quality and management of corporate governance (G) and how this "factor" can positively or negatively influence stock price performance.

In line with the surge in interest in climate change mitigation and adaptation, circular economy and biodiversity issues, research has also documented a direct link between the environmental (E) performance of firms and stock price performance.

More recently, linked to the COVID-19 pandemic, the global health crisis, changing demographics, geopolitics and the impact of globalisation, there is also an increasing investor focus on the impact of social issues and stock returns, with a particular emphasis on health, safety, and wellbeing , as well as on human capital management issues such as employee satisfaction, and diversity and inclusion¹.

More recent studies show a diversified spectrum of ESG drives ranging from regulatory compliance to investor expectations as well as peer group influencers:

Anti-woke, anti-DEI, and anti-ESG backlash in the US

The rise of "anti-woke" and "anti-DEI" (Diversity, Equity, and Inclusion) movements, particularly in the US, poses a significant challenge to ESG initiatives but also to the former "Western World Order".

In turn, some US companies are scaling back their DEI efforts and broader ESG commitments, often in direct response to political pressures and legal challenges. Other firms, with a longer term view, are re-affirming their calls to sustainable causes and actions.

Sustainable investment funds have come under similar pressures and scrutiny, with US funds reporting de-labelling efforts and decreasing fund flows. Meanwhile, fund flows in the EU and globally continue to grow, regardless of more stringent regulatory disclosure, green washing and labelling requirements².

Regulatory clarity in the EU

In the European Union, regulatory clarity, consistency and comparability is crucial for the successful implementation of ESG strategies, at corporate, investor and capital markets level.

Over the last few years, the EU has introduced several regulations, such as the Corporate Sustainability Reporting Directive (CSRD) for companies, as well as the Sustainable Finance Disclosure Regulation (SFDR) for investors, and the Taxonomy Regulation (EUT) for both stakeholder groups, to promote transparency and combat greenwashing³.

Keeping up with these regulations can be challenging for actors across the value chain, including ESG data and information "reporters", data "aggregators" and data "consumers", requiring continuous adaptation and adjustments of policies, processes and disclosure practices, dependent on in-house expertise and effective and increasingly digital, operational management.

The importance of staying in the ESG space

Despite emerging challenges, the importance of ESG, its implications, achievements and impacts, cannot be overstated.

Industry developments across sectors, such as renewables, automobiles / electric vehicles and sustainable finance, shows that strong ESG performance and innovation can provide a competitive advantage, build investor confidence, and ensure long-term sustainability.

Companies that prioritise ESG are better positioned to navigate regulatory and often operational challenges, manage risks, leverage human capital, and ultimately meet stakeholder expectations.

Moreover, and as studies such as Morgan Stanley's investor survey on "Sustainable Signals"⁴ frequently show, global awareness of environmental and social issues grows, and the next generation, faith-based and women investors continue to favour businesses and investment opportunities that lead in ESG.

Hence these are likely to enjoy enhanced reputational benefits and customer loyalty for years to come.

More emphasis on the ESG data ecosystem

Underpinning an ESG strategy and tactics is clear, concise and contextual data and information for decision-making. Thereby, the key to the future of ESG in a normative and regulatory context is data and are data providers.

Sourcing sustainability data directly from reporting entities or public information sources can be costly and resource-intensive, requiring substantial investment in time, personnel, and technical infrastructure to collect, collate, and quality-assure the data.

Data providers use different methodologies in creating ESG ratings and scores, often weighting certain metrics more than others.

Users are also able to tailor these products for their own needs, their own priorities (e.g. some may be more focused on climate solutions, whereas others may be more focused on labour-relations and human capital) and their own investment beliefs.

As a result, the range of products available, both within each provider and across them means that these tools cater to a wide range of users.

Beyond their role in producing sustainability data and content, data providers play an important role in shaping and informing the entire sustainability ecosystem. Data providers offer insights into emerging sustainability trends and issues, suggest potential metrics and indicators to measure policies and performance at corporate, sovereign, sector or industry level, and thereby influence emerging disclosure standards and regulations across the globe.

ESG data providers also support in the implementation of sustainability disclosure regulation by producing guidance and support for companies or investors to improve their reporting practices.

A data strategy is hence paramount for decision making, to establish the roadmap for a "multi-vendor, single access point", a data marketplace or a proprietary data management approach, for a holistic view of combining data with research and insights and for derived data models, and analytics.

Conclusion

ESG is here to stay and encompasses a wide range of entity- and product-level initiatives across the entire data ecosystem. Hence, the path to effective ESG and long-term value creation is and remains complex, influenced by geopolitical dynamics, societal backlash, and interdependent on political, societal, and regulatory demands.

However, the benefits of staying committed to ESG principles far outweigh the challenges. But overcoming the challenges in ESG implementation requires a strategic, cognizant and multifaceted approach, including:

1. Conduct materiality assessments: identify the ESG issues most relevant to an organization, asset class, and / or stakeholders. This helps prioritise efforts, revenues and resources on areas with the greatest impact.
2. Set measurable goals: establish clear, measurable ESG goals aligned with industry benchmarks and international frameworks. This ensures accountability and facilitates progress tracking at entity and product level.
3. Enhance transparency and reporting: improve transparency by regularly reporting ESG performance. Use standardized reporting frameworks like the Global Reporting Initiative (GRI), the European Sustainability Reporting Standards (ESRS) or targeted thematic frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD) to ensure consistency and comparability on ESG criteria, topics and requirements.
4. Engage stakeholders: engage with stakeholders, including employees, investors, and customers, to understand their expectations and incorporate their feedback into ESG strategies, approaches and products. This builds trust and aligns company and investor goals with broader stakeholder values, ethics and principles.
5. Integrate ESG into core strategy: embed ESG considerations into the core business strategy and operations. This includes tying executive compensation to ESG performance and incorporating sustainability into financial planning. It also fosters holistic and integrated decision making, e.g. when M&A, investment and product decisions are being formed and prioritised.
6. Stay informed on regulations: keep abreast of regulatory developments, especially in regions like the EU or APAC where ESG regulations are evolving rapidly. This helps ensure compliance and avoid potential penalties, sanctions and controversies which in turn can impact organisational ESG ratings and valuations.
7. Foster a culture of sustainability: promote a culture that values sustainability and ethical practices. This can be achieved through training programs, front-office engagement, leadership commitment, and recognizing, inspiring and rewarding sustainable practices among the workforce.
8. Leverage technology and innovation: utilize technology to enhance ESG initiatives, such as using data analytics for better decision-making and adopting green technologies to reduce environmental impact. This is a core area for product innovation and, in turn, green revenue creation and EUT alignment.
9. Collaborate and Partner: collaborate with other organizations, industry groups, and NGOs to share best practices, resources, and innovations. Partnerships can amplify impact, drive and scale collective progress at entity and at product level. Organisations such as the Future of Sustainable Data Alliance (FoSDA) supports common policy and markets goals for the ESG data management industry.
10. Monitor and adapt: regularly monitor ESG performance, at company and investor level, and adapt strategies and approaches as needed. This ensures continuous improvement, agility and responsiveness to emerging challenges and opportunities and provides a Six Sigma⁵ environment for ESG management.

By adopting these strategies and tactics, companies and investors can effectively navigate the complexities of ESG implementation, regulatory scrutiny, operational due diligence, and drive sustainable growth within key parts of an organisation and within ecosystem-wide decision-making processes, based and dependent on ESG data and information management.

Martina Macpherson is Head of ESG Product Strategy at SIX BFI, Board Member at the Future of Sustainable Data Alliance (FoSDA), and Consultative Member, Sustainability Standards Committee at ESMA.

Sources

1. For an overview on ESG drivers in portfolio management, please see Kartik Chawla, Martina Macpherson, Alexis Royer and Daniel Ung, Analysing ESG policy, market and portfolio construction considerations, in: ESG Investing and Analysis - A Practitioner's Guide, RiskBooks, 2022, link: https://riskbooks.com/esg-investing-and-analysis-a-practitioner-s-guide
2. See Morningstar, Inflows Surged for European Article 8 ESG Funds in Q4, February 2024, link: https://www.morningstar.com/sustainable-investing/inflows-surged-european-article-8-esg-funds-q4
3. For further references, see e.g. Martina Macpherson, Meeting the EU's Corporate Sustainability Disclosure Rules – Mission (Im)possible?, in: Research Handbook on Sustainability Reporting, 2024, p. 224 ff. Link: https://www.e-elgar.com/shop/gbp/research-handbook-on-sustainability-reporting-9781035316250.html?srsltid=AfmBOopitZJaPCwoNgiWezZW3E1pA47cvRncAgisaom6K_ibimQG5t5f
4. See e.g. Morgan Stanley, Sustainable Signals Understanding Individual Investors' Interests and Priorities, 2024, link: https://www.morganstanley.com/content/dam/msdotcom/en/assets/pdfs/MSInstituteforSustainableInvesting-SustainableSignals-Individuals-2024.pdf
5. To note: "Six Sigma" is a set of methodologies and tools used to improve business processes by reducing defects and errors, minimizing variation, and increasing quality and efficiency. The goal of Six Sigma is to achieve a level of quality that is nearly perfect, with only 3.4 defects per million opportunities.

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