Current ESG frameworks measure how environmental and social risks may harm shareholders, rather than how business may harm the world. We show how and why this approach is misguided.
Informed by legitimate scholarly and journalistic critiques of ESG investing, the report offers a dramatically different approach that can revive the original goals of ESG investing—namely, using investment decisions to reflect investor values and to create incentives for companies to conduct themselves in a more responsible fashion.
The report makes a series of pragmatic recommendations, including:
Recommendations to ESG Investment Advisers and Data Providers:
Recognize that the ultimate goals of ESG investing are to protect the environment and society, and to faithfully express investors’ values.
Label and market your financial products forthrightly. Tell the public your objectives and reveal every facet of your methodology.
Be willing to exclude broad swathes of the market in assembling values-driven portfolios or benchmark indices. Strive to create a fund with holdings that will not appall investors who are genuinely values-driven.
Use metrics that measure real-world outcomes—not meaningless procedures, or empty promises of future outcomes.
Abandon “Best in Class” scoring. Instead of comparing a firm to its peers, judge it by an objective standard of responsible conduct. If every firm in a sector is objectively failing, then exclude the sector.
Recommendations to the SEC:
Move forward swiftly on every ESG front where progress has stalled: (a) finalize the rule to curb “greenwashing” by investment advisers; (b) finalize the rule on “climate disclosure” by corporations; and (c) propose the rule on “human capital disclosure” by corporations. Crack down on deceptive marketing to restore integrity to the ESG marketplace. Mandate that companies report more and better data as the first essential step to reforming ESG investment.
In the rule on human capital disclosure, compel both public and private issuers to report on the size and compensation of their workforce. Require a breakdown of all data by country and locality to enable comparisons with the local living wage.
Fill the void in basic knowledge of the indirect workforce by requiring issuers to report the above data on all forms of outsourced or contingent labor. Broadly define the indirect workforce to encompass all U.S. or non-U.S. outsourced workers, and all fairly attributable U.S. or non-U.S. employees of franchisees, contractors, subcontractors, as well as firms in the global value chain that are so tethered to a listed U.S. company that the issuer specifies their standards or practices.
In the rule on climate disclosure, brush aside the attempt by the fossil fuels lobby—and its allies in asset management—to weaken the keystone requirement that firms report “Scope 3” emissions of greenhouse gases by suppliers, customers, and users.
In the rule on greenwashing, clarify that investment advisers and investment companies—including ESG information providers—must be transparent on every dimension of every system of ESG rating or ESG investment selection that they design or employ. Demand transparency on every assessed attribute, every metric of assessment, the weight assigned to each variable, the precise scoring methodology, and the scores awarded to each rated entity.