Therefore, it is of the utmost importance that an increasing number of people understand the structure of the entire ESG and sustainability, or simply the non-financial data universe.
Comparing apples and oranges: dividing data that does not belong together
Everyone is familiar with the old adage that one should avoid comparing apples and oranges. This analogy holds true when discussing ESG as well.
Just as these two fruits differ significantly in taste, texture and appearance, ESG ratings encompass a diverse array of criteria that cannot be directly compared due to their distinct nature. Even more true once we start to talk about sustainability.
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For instance, environmental factors encompass issues like carbon emissions and resource usage, while social factors involve labour practices and community engagement, and governance factors focus on board structures and ethical decision-making.
The complexity and diversity of these elements make direct comparisons akin to comparing differing elements, and this analogy emphasises the need for a nuanced approach when analysing ESG matters.
Furthermore, the potential range of terminologies someone may encounter is vast, and few industries are as inundated with acronyms as the ESG sector. Conversely, it's crucial to acknowledge that the terminology, once dominated by ESG or, some years ago, SRI (socially responsible investing), has undergone gradual evolution. Although these semantic shifts might be vexing due to the perpetually changing landscape, they are essential for accurately reflecting scientific advancements.
At the beginning of everything sits the data
However, let's look at this from the initial starting point. At the very outset, there is data. In the context of ESG, this predominantly entails non-financial data, crucial for analysis.
To delve into the specifics of non-financial data from a corporate standpoint, this includes metrics such as greenhouse gas emissions (environmental data), work-related accidents (social data) and board independence (governance data). These examples encapsulate just three facets of the foundational pillars; E, S and G.
The catalogue of underlying data points is extensive, numbering in the hundreds. For instance, vital data points encompass revenue breakdowns and the methodologies companies employ to generate their revenues.
Sophistication on top
Interpreting these raw data points can prove challenging, further complicated by the array of methodologies layered atop them. Frequently, the same data points are funnelled through diverse methodologies, creating variation in outcomes.
This is precisely where the distinction between apples and oranges becomes necessary. ESG ratings emerge from shared methodologies, visible across multiple platforms and publication websites. Notably, ESG ratings typically lack a sustainability dimension; instead, they revolve around risk and opportunity ratings. These ratings aim to enhance comprehension of a company's or fund's potential future performance by gauging how environmental factors affect the entity.
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However, sustainability operates in reverse. It seeks to comprehend how the company impacts the world and whether these influences are positive or negative. To evaluate this, diverse methodologies exist, many rooted in positive impact or aligned with the United Nations Sustainable Development Goals (SDGs).
These methodologies, while theoretically employable on the same underlying data, entail markedly distinct interpretations.
Is it an apple or is it an orange? How to identify the difference
Every child can easily differentiate between an apple and an orange.
However, when it comes to the same principles of understanding ESG and sustainability methodologies, even some professionals struggle to compare like with like.
It's because of this that it is even more crucial to consistently emphasise the important distinctions of what makes an apple and an orange different.
For ESG and sustainability it is important to ask the right questions, and dig deeper. Without understanding the fundamentals there is no way to understand the actual message.
So, is the term ESG doomed to die?
Probably, yes. Political pressure is strong and the industry is struggling. But who is talking about SRI today? Nobody, anymore. So, words can come and go, but that will clearly not change that the underlying non-financial data is an important additional information to take an investment decision.
Whether we call this data or approach ESG, SRI, responsible investing or any other term does not make a difference. The important part is that we clearly differentiate the apple from the orange and ESG from sustainability.
Matthias Breier is head of ESG product at FE fundinfo