For more than 20 years, the use of environmental, social and governance criteria (ESG) has gained traction among socially responsible investors, but multiple hurdles have kept this movement from fully entering the mainstream.
Business for Social Responsibility (BSR) announces a new report, "Environmental, Social and Governance: Moving to Mainstream Investing?" which examines how mainstream financial institutions are currently incorporating ESG criteria, the barriers that are preventing its progress – and the potential solutions to overcoming these challenges.
"Although many studies, such as those by the United Nations Environment Programme Finance Initiative (UNEP FI), show a positive association between investors’ use of ESG criteria and enhanced financial performance, the data is still inconclusive, and mainstream investors remain skeptical," said Laura Commike Gitman, BSR Director, Advisory Services. "This report looks beyond socially responsible investors and explores how mainstream financial institutions can advance the use of ESG criteria to maximize financial performance."
The report outlines the five main barriers to mainstream integration of ESG criteria – and offers advice for how financial institutions, global businesses and others can overcome them:
Lack of data: Due to the scarcity of evidence linking ESG criteria to financial returns, many investors have yet to integrate ESG criteria in investment decisions. For those considering using ESG criteria in valuation, there are a few promising examples to learn from, such as Goldman Sachs’ "GS Sustain Focus List," which predicts top corporate performers by evaluating how well they integrate ESG criteria into their businesses. This list has outperformed the world stock index MSCI by 25 percent since August 2005.
Insufficient reporting of ESG data: Because there is not yet a standard for disclosure of ESG performance, it is difficult for investors to compare company performance on these issues. Companies can help reduce this challenge by increasing disclosure and employing report standards such as the Global Reporting Initiative, which provide guidance on how organizations can disclose their sustainability performance.
Disparity between short-term pressure and long-term investments: Shareholder demands for strong short-term financial performance often compete with ESG investments, which are longer term by nature. Companies need to understand the long-term payoff, and investors need to be open to rewarding companies who invest for the long run.
Lack of capacity among investment professionals: Investors trained in financial analysis are not fully equipped to evaluate ESG criteria. To overcome this challenge, several investment companies have begun training their investment professionals on ESG criteria, some financial institutions have hired specialists to work solely on these issues, and some educational institutions have begun incorporating ESG issues into MBA and CFA programs.
Cynicism toward ESG: Cynicism is one of the fundamental barriers to mainstream acceptance of ESG criteria. In addition to the barriers outlined above, investors and businesses need to approach ESG with a different mindset, which may mean departing from business as usual. Positive data will help, as investors begin to trust that using ESG criteria to evaluate good investments pays off.
"Using the information in our report, mainstream investors and businesses will learn how to overcome common challenges and integrate ESG criteria into investment decisions," said Gitman. "Once this happens, more mainstream investors will begin to analyze ESG issues as part of their overall assessment of a company – positively impacting both financial results and sustainability."