ESG funds are growing, but now there is the problem of credibility

ESG funds are growing, but now there is the problem of credibility

ESG can be defined as the best performing segment in asset management, with ESG funds growing 53% year-on-year in 2021, to $ 2,700 million, and with 7 out of 10 investors declaring they want to invest in those is attentive to its social and environmental impact, as shown in a report prepared by EY And Oxford Analytica.

But phenomena such as greenwashing or regulatory excess (there are 870 policies and regulations in the world with 225 additions or revisions in 2021 alone) hinder its credibility.

To these factors, typical of the ESG sector, are added those exogenouswhich affect erga omnes on the economic system, such as rising inflation and the social and economic consequences of the conflict in Ukraine, which add to the long tail of the pandemic and the crisis in the availability of raw materials.

Trust in the ESG ecosystem serves to ensure that stakeholders have an identical perception of it to the more consolidated one of financial reporting “which, moreover, has normally shown little attention to environmental and social issuesHe observes Riccardo GiovanniniClimate Change and Sustainability leader of EY Italy.

The different legal systems and the different social and political contexts change the principles on which they are based standard and regulations governing the information on sustainability.

As a result, the administrations of different countries move at different speeds in regulating sustainability information.

There is essentially no agreement on what ESG factors should include, how to apply the metrics and how to use the available data.


Traditional data and ESG logic

Traditional data and ESG logic
An example of how traditional financial information affects ESG funds (source EY – Oxford Analytica)

For Giovannini “it is essential to refocus attention on the concept of sustainability itself, so that it can be shared by all stakeholders in order to really measure the commitment of companies on the issue. This would avoid running the risk of sustainability being relegated only to a regulatory compliance issue“.

The EY and Oxford Analytica report outlines five themes that need to be addressed to give more strength to the ESG criteria. All essentially focus on building an ecosystem of information on sustainability.

Increase transparency on the ESG rating

With the composite indicators a company receives a score on a wide range of ESG issues, with different weights assigned to each issue to calculate an overall ESG rating. These are factors that range from climate change to pollution and waste, to fiscal transparency.

Need to increase the transparency and an understanding of composite ESG ratings, because those interested in managing the financial riskthe lack of transparency on the weighting of ESG issues reduces clarity and decision-making utility.

In the composite approach the lack of consent on definitions and calculation methodologies hinders the analysis of the environmental performance of an organization. And also the social issues (human rights, labor standards, gender equity) can be more difficult to quantify than an agreed benchmark, given the social and political differences between different jurisdictions.


The kaleidoscope of sustainability

The kaleidoscope of sustainability
The complexity of building an information ecosystem consistent with ESG objectives (source EY – Oxford Analytica)

Social information and financial questions

The second theme is to increase the understanding the different uses of information on sustainability.

Sustainability information is used to evaluate the financial risk and to evaluate thesocial impact. Uses that are not mutually exclusive, but that can be confusing.

So far theinformation ecosystem on sustainability has evolved to meet the expectations of stakeholders who are primarily interested in assessing financial risk.

Most ESG reporting regimes, as well as all major ESG rating providers, they do not measure a company’s impact on societybut its relative exposure to financial risks and opportunities.

However, the growth of ESG investments is driven by young millennial and Gen Z investors, for whom it is imperative to prioritize social and moral considerations. It must therefore be understood, and here lies much of the problemwhether the current ecosystem of sustainability information serves both financial and social impact assessment.

Standards are needed to build trust in ESGs

The third way is to succeed in certify ESG data in a manner independentstandardized and rigorous, just like financial reporting.

It is the certification of the data that it creates confidence in the ecosystem of sustainability information.

Markets will increase the demand for independent certifications related to sustainability information. USA and EU they are already considering mandatory certification requirements for sustainability disclosure.

As the demand for certifications increases, sustainability information will need to be based on a strict reporting system that provides accurate and unbiased information.

This can happen with a regulation company that includes a solid internal control system with management roles, BoD, internal control committee, with a form ofexternal independence and with regulatory supervision.


How climate change is assessed

How climate change is assessed
The weight of climate change metrics in the ESG rating (source EY – Rhodium Group)

Comparable and interoperable sustainable finance taxonomies

For true transparency and comparability in sustainability information, jurisdictions will need to use taxonomies based on complementary principles, i.e. systems that determine which economic activities should be considered sustainable and can help clarify uncertainties about what is considered sustainable and what is not. it is.

For example, the EU taxonomy serves to help European countries to increase sustainable investments and to implement the European Green Deal. The EU itself is working with China to define a taxonomy based on common elements.

Bringing emerging economies into the ESG world

It is thought that the emerging economies they will produce the majority of global greenhouse gas emissions by 2050 and will be the most exposed to the consequences.

It is therefore necessary to involve them in the ecosystem of information on sustainability, reducing the entry barriers to the ESG market.

Here the work of defining international standards carried out byInternational Sustainability Standards Board it could help emerging countries to adopt them.

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