ESG stands for Environmental (environment), Social (society), and (corporate) Governance and references the three central factors we would like to report on and measure. ESG has risen to heady heights on the back of Larry Fink’s, #BlackRocks founder and CEO, super letters; Bill Gates New book How to avoid a Climate Disaster, which is good and; initiatives like EarthShot, which I love.
The purpose of an ESG focus is to make more balanced decisions that create long term sustainable activities, reduce detrimental societal impacts and provide better insight and transparency into how we make decisions/ judgements. There is no universally agreed definition, which probably does not matter as it is about the intent to make and justify decisions and judgments in a volatile, uncertain, complex and ambiguous world.
In March 2021, much has been reported on Tariq Fancy, BlackRock’s onetime chief investment officer for sustainable investing, following a USA Today interview. Better to read Jon Hale’s analysis on Medium
Starting with Better “Outcomes” This is the central idea of ESG, a desire to make better decisions, creating better outcomes, let’s not go those on how we choose. To make better decisions, we have to recognise more compromises, which means that we will be operating at Peak Paradox, which is problematic. As explored here, we will not get our best decisions operating at Peak Paradox, so how do we balance the conflicting purposes. This is the point of Governance; to make sure that we can justify those choices and hold those who make them accountable.
Peak Individual Purpose. An individual has full agency to believe or not believe and to act or not to act. An individual’s belief and action do not impact ESG as a tool, but our actions or not directly impact our economics, market and therefore, us, our environment, and society. Alignment between your belief and action will reduce compromise and tensions, but this is for an individual to comes to terms with.
Peak Work Purpose. Governance takes priority at this peak. In of itself, Governance will not change anything; it provides a record of what you said you would do (decided and how that decision was taken), aka your fiduciary duties as a Director and did you do it. I have explored here what it means to think about the next 1000 years of governance as it reverts to be intergenerational.
Peak Society Purpose. The societal aspects become the priority over the other aspects of ESG. This changes the emphasis to consider how society will benefit from the decision and the outcome. It is evident that performance measurement, KPI, BSC create conflicts with ESG as they create individual motivations. We appear to lack the linkage between what we expect from staff for better efficiency and more effectiveness and how to balance better decisions for society. As a fund manager or risk investor, when the CEO releases their results with a note saying they have missed revenue/ margin targets as an existing client failed their ESG audit and was let go, OR they did not take on a new client as they did not pass the ESG hurdles; do we celebrate, set a premium and mark as a buy or not? This is the point Tariq Fancy is making, IMHO.
An important point here is that players will game the market. Whilst some are trying to make better long term decisions; others will focus on gain for themselves because of their incentives and motivations. The complexity of markets and derivatives means that a focus on better outcomes will not create them on their own.
Peak Human Purpose. The environment and environmental (climate) become the priority. For primary human survival, we need food and water. To continue, we need to reproduce. Without a doubt, the earth will continue irrespective of what humans do to it; our question remains, “What quality of life do we want and what quality of life would we like future generations to have?” These questions are tricky as we immediately become involved in paradox as we are pulled towards the other peaks and personal perceptions.
ESG focuses on three peaks but misses Peak Individual Purpose.
As a takeaway, ESG focuses on three peaks but misses Peak Individual Purpose. When we start to unpack our incentives and motivations, we uncover conflicts. Because we have a misalignment between ESG and individual incentive/ rewards, especially in the risk and capital market, we have created with ESG a perfect market for individuals to game. The game will not lead to better decisions or better outcomes.