New state legislation will prohibit “public entities” from any investment activity that examines environmental, social and governance factors, starting July 1. While ESG has been a controversial topic for some time, it is now crucial that public opinion is heard and that folks understand how ESG fits into our economy.
ESG stands for Environmental, Social and Governance. It is the newest acronym in a growing and evolving market of ethical investing. ESG funds factor a company’s carbon footprint, supply chain, fair wages, diversity and internal auditing into their investment strategy.
While there are similarities between ESG and Socially Responsible Investing, the differences are where most critics take issue. It is a personal decision and preference to invest in a private company that is certified Fair Trade, or makes solar panels, for example, and divest from fossil fuels or a company under investigation.
ESG gives stakeholders, not only shareholders, more power to impact a firm’s actions. This matters because, over the last several decades, we have watched the negative externalities of the market exponentially impact our country and world. Wildfires, hurricanes and flooding have endangered communities and destroyed infrastructure. Inequity has disenfranchised workers, re-sparking social movements and causing the resurgence of unions. Lack of governance as firms grow has led to exploitation, investigations and lawsuits.
Roughly half of Americans own stocks or invest, but this percentage decreases as you look at younger generations. Yet, young and low-income people will be proportionally more impacted by climate change and future market volatility.
ESG not only has the potential to give consumers and investors a more complete picture of how firms are doing business but how those businesses’ practices are costing them in the long run.
Those who fear a future in which investment in fossil fuels is passed over due to ESG should note that the three categories are ranked equally within the framework. Oil & gas companies can still be rated highly if their social and governance practices score strongly. Though some criticize the subjectivity of ESG scoring frameworks, scientific data is not subjective, nor is economic data indicating the high profitability of companies with healthy work environments. The value that ESG seeks to define is good business. Furthermore, ESG creates another incentive for firms to ensure ethical governance, which mitigates future political, reputation and legal risks.
Of course, as is true in any emerging market or financial trend, there are several commonly recognized areas for improvement with ESGs. The Securities and Equities Commission (SEC) is investigating the validity of a large financial institution’s ESG asset claims. Three firms control the majority of ESG assets. Their practices have been called into question recently over transparency issues. In May, the SEC called for new protocols increasing disclosures of investments categorized as ESGs.
Despite these concerns, it is important to remember that higher standards of operation and increased competition take time to develop in every new industry or finance market. Using ESG scoring to invest should not be made illegal because it’s an emerging trend. It should be investigated, discussed and improved, not dismissed nor acclaimed as a perfect solution to the intersectionality of climate change.
ESG has the potential to provide insights for the growing number of investors placing importance on factors beyond financial return. These frameworks are another step toward responsible investing, corporate accountability and, ultimately, resilience. Casting them aside as flawed removes a way of addressing the environmental, social and economic realities that face our communities. Right now, we need every tool to address the climate emergency and expanding inequality. The solution is working to make ESG better, not throwing it out.
The nonprofit Sun Valley Institute focused on advancing “community resilience locally by educating, investing, and collaborating to ensure that the economy, environment and people thrive,” according to the organization.
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