Environmental, social, and governance

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Environmental, social, and governance (ESG) is shorthand for an investing principle that prioritizes environmental issues, social issues, and corporate governance.^[1] Investing with ESG considerations is sometimes referred to as responsible investing or, in more proactive cases, impact investing.^[1]

The term ESG first came to prominence in a 2004 report titled "Who Cares Wins", which was a joint initiative of financial institutions at the invitation of the United Nations (UN).^[2] By 2023, the ESG movement had grown from a UN corporate social responsibility initiative into a global phenomenon representing more than US$30 trillion in assets under management.^[3]

Criticisms of ESG vary depending on viewpoint and area of focus. These areas include data quality and a lack of standardization; evolving regulation and politics; greenwashing; and variety in the definition and assessment of social good.^[4] Some critics argue that ESG serves as a de facto extension of governmental regulation, with large investment firms like BlackRock imposing ESG standards that governments cannot or do not directly legislate.^[5] This has led to accusations that ESG creates a mechanism for influencing markets and corporate behavior without democratic oversight, raising concerns about accountability and overreach.^[6][7]

Investment decisions are predominantly based on the potential for financial returns for a given level of risk.^[8] However, there have always been many other criteria for deciding where to place money—from political considerations to heavenly reward.^[9]

In the 1970s, the worldwide abhorrence of the apartheid regime in South Africa led to one of the most renowned examples of selective disinvestment along ethical lines. As a response to a growing call for sanctions against the regime, the Reverend Leon Sullivan, a board member of General Motors in the United States, drew up a Code of Conduct in 1977 for practising business with South Africa.^[9] What became known as the Sullivan Principles (Sullivan Code) attracted a great deal of attention. Several reports were commissioned by the government to examine how many US companies were investing in South African businesses that were contravening the Sullivan Code. The conclusions of the reports led to mass disinvestment by the US from many South African companies. The resulting pressure applied to the South African regime by its business community added great weight to the growing impetus for the system of apartheid to be abandoned.^[10]

In the 1960s and 1970s, the economist Milton Friedman, in response to the prevailing mood of philanthropy, argued that social responsibility adversely affects a firm's financial performance and that regulation and interference from "big government" will always damage the macro economy.^[11] His contention that the valuation of a company or asset should be predicated almost exclusively on the financial bottom line (with the costs incurred by social responsibility being deemed non-essential) was prevalent for most of the 20th century (see Friedman doctrine). Towards the end of the 20th century, however, a contrary theory began to gain ground. In 1988 James S. Coleman wrote an article in the American Journal of Sociology titled "Social Capital in the Creation of Human Capital", the article challenged the dominance of the concept of 'self-interest' in economics and introduced the concept of social capital into the measurement of value.^[8]

There was a new form of pressure applied, acting in a coalition with environmental groups: using the leveraging power of collective investors to encourage companies and capital markets to incorporate environmental and social risks and opportunities into their decision-making.

Although the concept of selective investment was not a new one, with the demand side of the investment market having a long history of those wishing to control the effects of their investments, what began to develop at the turn of the 21st century was a response from the supply-side of the equation. At the time, this field was typically referred to as ethical or socially responsible investment. The investment market began to pick up on the growing need for products geared towards what was becoming known as the Responsible Investor. In 1981, Freer Spreckley, the creator of Social Enterprise, published SOCIAL AUDIT — A Management Tool for Co-operative Working, in which he first introduced the idea of a set of internal criteria that social enterprises and other organisations should use in their annual planning and accounting. These were financial viability, social wealth creation, organisational governance, and environmental responsibility, and they became known as social accounting and auditing. Later on, in 1998, John Elkington, co-founder of the business consultancy Sustainability, published Cannibals with Forks: the Triple Bottom Line of 21st Century Business, in which he identified the newly emerging cluster of non-financial considerations that should be included in the factors determining a company or equity's value. He coined the phrase the "triple bottom line", referring to the financial, environmental, and social factors included in the new calculation.^[12][13] At the same time, the strict division between the environmental sector and the financial sector began to break down. In the City of London in 2002, Chris Yates-Smith, a member of the international panel chosen to oversee the technical construction, accreditation, and distribution of the Organic Production Standard and founder of a branding consultancy, established one of the first environmental finance research groups. The informal group of financial leaders, city lawyers, and environmental stewardship NGOs became known as The Virtuous Circle, and its brief was to examine the nature of the correlation between environmental and social standards and financial performance. Several of the world's big banks and investment houses began to respond to the growing interest in the ESG investment market with the provision of sell-side services; among the first were the Brazilian bank Unibanco, and Mike Tyrell's Jupiter Fund in London, which used ESG based research to provide both HSBC and Citicorp with selective investment services in 2001.

In the early years of the new millennium, the major part of the investment market still accepted the historical assumption that ethically directed investments were by their nature likely to hinder financial returns. Philanthropy was not considered to aid profitable business, and Friedman had provided a widely accepted academic basis for the argument that the costs of behaving in an ethically responsible manner would outweigh the benefits. However, the assumptions were beginning to be fundamentally challenged. In 1998 two journalists, Robert Levering and Milton, brought out the "Fortune 100 Best Companies to Work For", initially a listing in the magazine Fortune, then a book compiling a list of the best-practicing companies in the United States with regard to corporate social responsibility and how their financial performance fared as a result. Of the three areas of concern that ESG represented, the environmental and social had received most of the public and media attention, not least because of the growing fears concerning climate change. Moskowitz brought the spotlight onto the corporate governance aspect of responsible investment. His analysis concerned how the companies were managed, what the stockholder relationships were, and how the employees were treated. He argued that improving corporate governance procedures did not damage financial performance; on the contrary, it maximized productivity, ensured corporate efficiency, and led to the sourcing and utilizing of superior management talents. In the early 2000s, the success of Moskowitz's list and its effect on companies' ease of recruitment and brand reputation began to challenge the historical assumptions regarding the financial effect of ESG factors.^[14] In 2011, Alex Edmans, a finance professor at Wharton, published a paper in the Journal of Financial Economics showing that the "100 Best Companies to Work For" outperformed their peers in terms of stock returns by 2–3% a year over 1984–2009, and delivered earnings that systematically exceeded analyst expectations.^[15]

In 2005, the United Nations Environment Programme Finance Initiative commissioned a report from the international law firm Freshfields Bruckhaus Deringer on the interpretation of the law with respect to investors and ESG issues. The Freshfields report concluded that not only was it permissible for investment companies to integrate ESG issues into investment analysis, but it was also arguably part of their fiduciary duty to do so.^[16][17] In 2014, the Law Commission (England and Wales) confirmed that there was no bar on pension trustees and others from taking account of ESG factors when making investment decisions.^[18]

Where Friedman had provided academic support for the argument that the integration of ESG type factors into financial practice would reduce financial performance, numerous reports began to appear in the early years of the century that provided research that supported arguments to the contrary.^[19] In 2006 Oxford University's Michael Barnett and New York University's Robert Salomon published an influential study which concluded that the two sides of the argument might even be complementary—they propounded a relationship between social responsibility and financial performance. Both selective investment practices and non-selective ones could maximise the financial performance of an investment portfolio, and the only route likely to damage performance was a middle way of selective investment.^[20] Besides the large investment companies and banks taking an interest in matters ESG, an array of investment companies specifically dealing with responsible investment and ESG based portfolios began to spring up throughout the financial world.

Many in the investment industry believe the development of ESG factors as considerations in investment analysis to be inevitable.^[21] The evidence toward a relationship between consideration for ESG issues and financial performance is becoming greater and the combination of fiduciary duty and a wide recognition of the necessity of the sustainability of investments in the long term has meant that environmental social and corporate governance concerns are now becoming increasingly important in the investment market.^[22][23] In addition, surveys of ultimate beneficiaries (on whose behalf savings and pensions are made) typically show high levels of support for considering social and environmental issues alongside long-run, risk-adjusted returns.^[4] ESG has become less a question of philanthropy than practicality.

There has been uncertainty and debate as to what to call the inclusion of intangible factors relating to the sustainability and ethical effectiveness of investments. Names have ranged from the early use of buzz words such as "green" and "eco", to the wide array of possible descriptions for the types of investment analysis—"responsible investment", "socially responsible investment" (SRI), "ethical", "extra-financial", "long horizon investment" (LHI), "enhanced business", "corporate health", "non-traditional", and others. But the predominance of the term ESG has now become fairly widely accepted. A survey of 350 global investment professionals conducted by Axa Investment Managers and AQ Research in 2008 concluded the vast majority of professionals preferred the term ESG to describe such data.^[24]

In January 2016, the PRI, UNEP FI and The Generation Foundation launched a three-year project to end the debate on whether fiduciary duty is a legitimate barrier to the integration of environmental, social, and governance issues in investment practice and decision-making.^[25]

This follows the publication in September 2015 of Fiduciary Duty in the 21st Century by the PRI, UNEP FI, UNEP Inquiry and UN Global Compact.^[26] The report concluded that "Failing to consider all long-term investment value drivers, including ESG issues, is a failure of fiduciary duty". It also acknowledged that despite significant progress, many investors have yet to fully integrate ESG issues into their investment decision-making processes. In 2021, several organizations were working to make ESG compliance a better understood process in order to establish standards between rating agencies, amongst industries, and across jurisdictions. This included companies like Workiva working from a technology tool standpoint; agencies like the Task Force on Climate-related Financial Disclosures (TCFD) developing common themes in certain industries; and governmental regulations like the EU's Sustainable Finance Disclosure Regulation (SFDR).^{[27][28][29][30]}

During the COVID-19 Pandemic, BlackRock, Fidelity, and Amundi among other asset management companies, placed pressure on pharmaceutical companies in which they had a large stake in to cooperate with each other.^[31]

In 2023, Leonard Leo and associated networks launched a campaign to dismantle ESG, with special targeting on climate-friendly investment. Consumers' Research and Republican attorneys general announced investigations into The Vanguard Group.^[32] Vanguard distanced itself from ESG investing as its CEO states that it's not compatible with its fiduciary duties to the investors. Fewer than 1 in 7 of their active equity managers outperformed the broad market in any five-year period and none of them relied exclusively on a net-zero investment methodology.^[33]

Responsible investing through ESG has been globally driven by the COP21 or the Paris agreement, and the UN 2030 sustainable development goals.

ESG factors and ratings took an established place in the finance realm. Indeed, the 2021 ESG assets market value was over $18.4 trillion worth of investments with a projected growth of 12.9% until 2026.^[34] ESG saw outflows for the first time in 2023.^[35]

The EU has a leading position in the sustainable funds market with 84% of global assets in this sector. Additionally, it stands as the most advanced and diversified market for ESG investments. In comparison, the US, following at a distance, accounted for 11% of these global sustainable fund assets by September 2023.^[36]

Global Sustainable Fund Statistics by region in 2023 Q3

	Flows	Assets		Funds
Region	USD Billion	USD Billion	% Total	#	% Total
Europe	15.3	2.293	84	5.608	73
United States	-2.7	299	11	661	9
Asia ex-Japan	2.0	67	2	539	7
Australia/New Zealand	0.0	31	1	268	4
Japan	-0.9	23	1	236	3
Canada	-0.1	31	1	336	4
Total	13.7	2.744		7.648

It is to be noted that amid allegations of greenwashing and stricter regulations, there is a notable decrease in funds incorporating ESG-related terms into their names. An increasing number of funds in the United States are removing ESG-related terms from their names, a trend not observed in Europe.^[36]

The University of Cambridge defines sustainable investments as it involves constructing a portfolio by selecting assets deemed to be sustainable or capable of enduring over the long term. It can also be seen as a resolute approach that excludes assets perceived as detrimental to long-term environmental and social sustainability.^[37]

ESG standards have been developed in response to the growing worldwide demand for more sustainable and socially responsible investments. Since the development in 1960 of these standards has evolved gradually and is the result of a global recognition of the importance of sustainability and social responsibility, it is difficult to determine precisely which countries needed these standards first. However, certain countries or regions are particularly active in promoting ESG standards. For example, European countries such as the Scandinavian countries (Denmark, Sweden, Norway) and countries like the Netherlands are pioneers in integrating ESG criteria into investment and corporate governance policies. Similarly, these Nordic countries tend today to score relatively well in many international assessments of ESG criteria.^[38]

Moreover, between 2007 and 2016, the number of traditional funds putting ESG criteria into perspective rose from 260 to over 1,000.^[39] Moreover, the number of investments incorporating ESG criteria is estimated to have doubled between 2019 and 2022. ^[40] Another study also claims that funds with an ESG commitment doubled over these three years, from 3% to 5%.^[41] Finally, one last study shows that there is real growth in global sustainable investment assets between 2012 and 2020, with asset value growth from 13.6 trillion USD to 35.3 trillion USD.^[42] This growth in ESG-compliant funds is, of course, in line with investors' growing interest in sustainable investment. However, lower returns for ESG funds over the last two years has led to a large decrease in investments.^[43]

As far as stakeholders are concerned, it's important to note that not all generations and countries are affected in the same way. Firstly, on a global scale, there are notable differences between regions in terms of companies' willingness and ability to address ESG issues in their investments. The results of various surveys seem to confirm these disparities, showing a more favorable trend in Europe, the Middle East, Africa (EMEA), and, Asia-Pacific, in contrast to North America. Indeed, a high proportion of respondents in Asia-Pacific (78%) and EMEA (74%) consider ESG issues, while a smaller majority in North America (59%) attach importance to them. This year's ESG ranking podium is exclusively European "Nordic countries", with Finland in first place, followed by Sweden in second and Iceland in third. These regional disparities may change over time, although the underlying reasons for these differences are not fully understood. For example, in countries benefiting from developed markets and strict regulations, investors may assume that certain ESG issues are addressed by regulations, thus explaining a lower sensitivity to these topics.^[44]

However, comparing ESG ratings from one geographical area to another is not an easy task, especially in a global market. Variations in company ratings, particularly between Europe (in the best position) and North America (in the worst), may reflect the quality of reporting rather than the intrinsic quality of ESG practices.^[44] Disclosure requirements vary considerably between regions, and some binding regulations in Europe, such as the publication of a "non-financial statement" for companies with more than 500 employees, may positively influence the region's ESG ratings. At the same time, European investors' greater interest in ESG investments is also contributing to this trend.

New generations, such as Millennials and Generation Z, are showing a growing interest in ESG investing, aligning their values with their investment choices by favoring companies that have sustainable practices, respect human rights, promote diversity and are committed to positive actions for society. In fact, according to a survey conducted in 2021, around a third of Millennials often or only use investments that take ESG criteria into account, compared with 19% of Generation Z, 16% of Generation X and 2% of baby boomers.^[45]

However, it is important to challenge this generalized view of ESG investing. While some groups are showing increased interest, it's essential to recognize the diversity of perspectives and priorities across generations. This bias can lead to a simplified or even erroneous view of the real effect of ESG investments. Excessive focus on the most engaged generations may mask progress or shortcomings elsewhere, underlining the need for a more balanced and nuanced assessment of the effect of ESG investments.

The implementation of ESG practices differs across sectors. The sectors of the industry, information technology, consumer discretionary, and materials are the sectors that have the biggest interest in the ESG practice (see figure 2).^[46] According to the sector, the weights attributed to the relative importance of environmental, social, and governance factors change. Over time, the weighting of categories is subject to change. For instance, according to Nagy et al. (2020), the governance factor recorded a significant growth in weight, rising from 19% in 2007 to 27% in 2019 and then to 31% in 2020. Overall, an MSCI study revealed that: the average weight of the environmental pillar was 30%, social factors was 39%, and governance elements were 31% across all the sectors.^[47]

Another bias that the ESG instrument can exhibit is that larger companies generally have higher ESG scores compared to small and medium-sized enterprises (SMEs). Sustainability reports have so far been self-declared and unaudited, resulting in companies often seeking to present themselves in the best possible light. Furthermore, several studies have demonstrated significant data omissions, inaccurate figures, and unfounded claims ^{[citation needed]}.

The gap between the performance of large corporations and SMEs can have various explanations. According to studies, companies that provide more robust information tend to receive higher ESG scores, even if they have historically weak ESG practices or correspond to a higher overall ESG risk. The best ratings for these companies may be linked to their enhanced ESG compliances or because they allocate more resources to the preparation of their non-financial reports. For instance, Bristol-Myers Squibb, a large pharmaceutical company, maintains a high ESG rating even after being involved in recent controversies. In contrast, Phibro Animal Health, a small pharmaceutical company, receives a lower score, despite its commitments and compliances with ESG criteria.^[48] SMEs may also find it challenging to implement the necessary measurement frameworks.^[49]

ESG has been adopted throughout the United States financial industry to describe and measure the sustainability and societal influence of a company or business.^[50] MSCI, a global ESG rating agency, defines ESG investing as the consideration of environmental, social, and governance factors alongside financial factors in the investment decision-making process.^[51] Likewise, S&P highlights consideration of the ways in which environmental, social, and governance risks and opportunities can have material effects on companies' performance.

1. Environmental aspect: Data is reported on climate change, greenhouse gas emissions, biodiversity loss, deforestation/reforestation, pollution mitigation, energy efficiency and water management.
2. Social aspect: Data is reported on employee safety and health, working conditions, diversity, equity, and inclusion, and conflicts and humanitarian crises,^[52] and is relevant in risk and return assessments directly through results in enhancing (or destroying) customer satisfaction and employee engagement.
3. Governance aspect: Data is reported on corporate governance such as preventing bribery, corruption, Diversity of Board of Directors, executive compensation, cybersecurity and privacy practices, and management structure.

Issues driving Morningstar / Sustainalytics ESG Risk Ratings^[53]

Category	Issue	Contribution to ESG Risk Rating
Environmental 43.3%	Carbon - Own Operations	19.2%
	Resource Use	10.3%
	Emissions, Effluents and Waste	7.1%
	Environmental and Social Impact of Products and Services	6.7%
Social 34.1%	Human Rights	22.8%
	Occupational Health and Safety	7.5%
	Community Relations	3.8%
Governance 22.6%	Corporate Governance	11.9%
	Business Ethics	6.7%
	Human Capital	4.0%

Both the threat of climate change and concern over climate change have grown, so investors are choosing to factor sustainability issues into their investment choices to enable better risk-adjusted returns.^[54] The issues often represent externalities, such as influences on the functioning and revenues of the company that are not exclusively affected by market mechanisms.^[55] As with all areas of ESG, the breadth of possible concerns is vast (e.g. greenhouse gas emissions, biodiversity, waste management, water management) but some of the chief areas are listed below:^[56]

The body of research providing data of global trends in climate change has led some investors—pension funds, holders of insurance reserves—to begin to screen investments in terms of their effect on the perceived factors of climate change. Fossil fuel-reliant industries are less attractive.^[57] In the UK, investment policies were particularly affected by the conclusions of the Stern Review in 2006, a report commissioned by the British government to provide an economic analysis of the issues associated with climate change. Its conclusions pointed towards the necessity of including considerations of climate change and environmental issues in all financial calculations and that the benefits of early action on climate change would outweigh its costs.^[58] The main framework used globally is the Taskforce on Climate-Related Financial Disclosures (TCFD).

In every area of the debate from the depletion of resources to the future of industries dependent upon diminishing raw materials the question of the obsolescence of a company's product or service is becoming central to the value ascribed to that company. The long-term view is becoming prevalent amongst investors.^[21]

There is a growing belief that the broader the pool of talent open to an employer the greater the chance of finding the optimum person for the job.^[59] Innovation and agility are seen as the great benefits of diversity, and there is an increasing awareness of what has come to be known as the power of difference.^[60] However, merely holding mandatory diversity training is not enough to open companies to opportunities for targeted groups. Studies find the more a company intentionally integrates work teams, the more open it becomes to a diverse workforce; the US military is a prime example of races and genders working well together.^[61]

In 2006, the US Courts of Appeals ^{[clarification needed] [which?]} ruled that there was a case to answer bringing the area of a company's social responsibilities squarely into the financial arena.^[62] This area of concern is widening to include such considerations as the effect on local communities, the health and welfare of employees and a more thorough examination of a company's supply chain. One of the major frameworks used is the United Nations Guiding Principles on Business and Human Rights.

Until fairly recently, caveat emptor ("buyer beware") was the governing principle of commerce and trading. In recent times however, there has been an increased assumption that the consumer has a right to a degree of protection, and the vast growth in damages litigation has meant that consumer protection is a central consideration for those seeking to limit a company's risk and those examining a company's credentials with an eye to investing. The collapse of the US subprime mortgage market initiated a growing movement against predatory lending has also become an important area of concern.^[63]

Animal welfare concerns involve testing products or ingredients on animals, breeding for testing, exhibiting animals, or factory farms.^[64]

Out of the 435 ESG shareholder proposals that were recorded by the non-profit organization As You Sow in 2021, 22 were classified as conservative by the organization.^[65] The National Center for Public Policy Research has asked 7 companies to prepare a report on the BRT Statement of the Purpose of a Corporation. Other conservative proposals include reports on charitable contributions and board nominee ideological diversity.^[66]

Corporate governance refers to the structures and processes that direct and control companies. Good governance is seen to ensure companies are more accountable, resilient and transparent to investors and gives them the tools to respond to stakeholder concerns.^[67]

Corporate Governance in ESG includes issues from the Board of Director's view, Governance Lens watching over Corporate Behavior of the CEO, C-Suite, and employees at large includes measuring the Business ethics, anti-competitive practices, corruption, tax and providing accounting transparency for stakeholders.

MSCI puts in the Governance side of the bucket corporate behavior practices and governance of board diversity, executive pay, ownership, and control, and accounting that the board of directors have to oversee on behalf of stakeholders.^[68] Other concerns include reporting and transparency, business ethics, board oversight, CEO / board chair split, shareholder right to nominate board candidates, stock buybacks, and dark money given to influence elections.^[69]

The system of internal procedures and controls that makes up the management structure of a company is in the valuation of that company's equity.^[22] Attention has been focused in recent years on the balance of power between the CEO and the board of directors and specifically the differences between the European model and the US model—in the US studies have found that 80% of companies have a CEO who is also the chairman of the board, in the UK and the European model it was found that 90% of the largest companies split the roles of CEO and chairman.^[70]

In the United States Moskowitz's list of the Fortune 100 Best Companies to Work For has become not only an important tool for employees but companies are beginning to compete keenly for a place on the list, as not only does it help to recruit the best workforce, it appears to have a noticeable effect on company values.^[14] Employee relations relate also to the representation of co-workers in the decision-making of companies, and the ability to participate in a union.

Companies are now being asked to list the percentage levels of bonus payments and the levels of remuneration of the highest paid executives are coming under close scrutiny from stock holders and equity investors alike.

Besides executive compensation, equitable pay of other employees is a consideration in the governance of an organization. This includes pay equity for employees of all genders. Pay equity audits and the results of those audits may be required by various regulations and, in some cases, made available to the public for review. Hermann J. Stern differentiates four methods to include ESG performance in employee compensation:^[71]

1. ESG Targets (Objectives for activities, projects and ESG results set by the company as a goal)
2. ESG Relative Performance Measurement (compared to peers, on the basis of key figures the company considers relevant)
3. ESG Ratings Agencies (Refinitiv, S&P Trucost and RobecoSam, Sustainalytics, ISS ESG, MSCI ESG, Vigeo Eiris, EcoVadis, Minerva Analytics, etc.)^[72]
4. ESG Performance Evaluations (internal or independent performance assessment by means of expert opinions, based on internally and externally available objective and subjective facts)

The growing integration of environmental, social, and governance criteria into investment decisions has spawned a series of myths and preconceptions surrounding their true effectiveness and relevance. These misperceptions, which are widespread in the financial world, have often obscured the reality of the effectiveness of sustainable value investing.

Investors motivated by financial value, as well as those guided by ethical values, are now factoring ESG considerations into their decisions. This shift is not just an evolution of values-based listed stock selection, but a profound transformation of the investment paradigm. However, this progress comes up against persistent misconceptions.^[73]

During the last ten years, ESG investments have increased significantly in both the US and Europe. However, quantifying true ESG effects is tricky for several reasons. Firstly, despite the attention devoted to ESG in the literature, there is a real gap between theory and reality. The real effects of changes in investment practices are complicated to quantify because some variables are qualitative rather than quantitative. Secondly, the rating agencies that attribute ESG scores do not use the same metrics, which leads to different results. Overall, companies with high ESG scores have higher profits than others.^[46]

The social pillar deals with the assessment of both internal (workers) and external relationships (local community/consumers). This pillar focuses on human rights, privacy policies, working conditions, and initiatives that benefit underprivileged communities, among other things. Studies have shown that if the quality of the internal and external relationship is good, it generates a positive effect on the benefits of local sustainable development and worker well-being, as well as indirect financial benefits in addition to the financial performance of businesses.^[74] Particular contexts such as the COVID-19 pandemic have emphasized the pressure of the S-pillar. Indeed, in this particular context, the inequalities increase and most disadvantaged groups suffer more than the others.^[75]

However, there is a gap inside the regulatory framework because there is no common agreement on the assessment of the social pillar. Therefore, the rating agencies don’t use the same metrics which create a high divergence in the different evaluations.^[74] Moreover, the social pillar is difficult to measure because it relies on social aspects that are empirically limited and quantifiable, e.g. it refers to notions such as well-being, and discrimination which needs a deep understanding with a detailed analysis. To conclude, assessing the real effects of the social pillar is very tough.^[75]

The firm leadership, internal controls, audits, board diversity and composition, strategies, and policies are all included under the governance pillar.^[76] Regarding governance, it has been found that the financial performance of a business is influenced by its decision-making body. For instance, gender diversity improved CSR, decreased corporate social irresponsibility, and as a result, improved business performance. The size of a company's board and management experience were strongly correlated with its financial performance.^[47] CSR describes the sustainability tactics used by companies to make sure their operations are ethically acceptable. On the contrary, ESG are employed to evaluate the overall sustainability of an organisation. ESG are used as measures.^[77]

The Governance pillar offers considerable and high portfolio returns, according to early research using the ESG filter on value profitability and momentum indicators. In agreement with some findings, when the entire sample is taken under consideration, the environmental and governance indicators have a considerable negative effect on portfolio volatility and a favorable effect on portfolio return growth.^[78] According to the countries, some indicators are less important than others, and one of the last contributing ESG performance scores for the developing countries is governance.^[76]

The G scores (as well as the S score) are subjective measures and are more likely to be manipulated to elevate ESG performance. These two pillars (G and S) are also more subjected to greenwashing.^[76]

The Environmental (E) pillar of ESG assesses how an industry affects the environment by considering elements such as carbon footprint, pollution levels, resource management, dependence on fossil fuels, and efforts to address climate change. Addressing these issues is essential to the long-term financial stability of a company.^[79] Investors identify opportunities in eco-friendly activities, which can lead to competitive advantages in eco-friendly goods and services. Examples of these practices include the use of renewable energy, resource conservation, pollution reduction, and reduced carbon footprints.^[80] Despite the ESG’s attention, there is a significant research gap in the implementation of ESG practices to reduce carbon emissions in the industry.^[81]

A recent OECD evaluation on ESG assessed different E-score approaches. Both high and low correlations were found when comparing the E pillar score with the total ESG scores from various providers. This is because the rating agencies use different ESG measurements and primarily focus on environmental issues. The OECD’s study gives different surprising results. First, the research indicates that a higher score on the overall E pillar is not always associated with a low environmental effect by analyzing factors such as total CO2 and CO2 equivalent emissions, total waste created, total energy utilized, and total water usage. Unexpectedly, the general E pillar score and total CO2 emissions were found to be positively correlated. Secondly, two providers report that CO2 emissions are typically greater in companies with the highest ESG rankings. Similarly, different data providers assign higher E pillar scores to organizations that generate more hazardous and non-hazardous waste.^[47] Moreover, The influence of regulatory pressures in lowering businesses' pollution emissions is enhanced by environmental compensation. This implies enhanced environmental performance results from the combination of successful self-regulation achieved through governance mechanisms and regulatory pressure.^[82]

So having a high ESG score does not always seem to always have a positive and measurable effect on the environment, but leads to more financial incentives: a higher profit and larger market shares.^[83]

The three domains of environmental, social, and corporate governance are intimately linked to the concept of responsible investment (RI). RI began as a niche investment area, serving the needs of those who wished to invest but wanted to do so within ethically defined parameters. In recent years it has become a much larger proportion of the investment market. By June 2020, flows into U.S. sustainable funds reached $20.9 billion, nearly matching 2019's flows of $21.4 billion.^[84] By the end of 2020, flows into U.S. sustainable funds surpassed $51 billion.^[85] Globally, sustainable funds held $1.65 trillion in assets at the end of 2020.^[86]

ESG corporate reporting can be used by stakeholders to assess the material sustainability-related risks and opportunities relevant to an organization. Investors may also use ESG data beyond assessing material risks to the organization in their evaluation of enterprise value, specifically by designing models based on assumptions that the identification, assessment, and management of sustainability-related risks and opportunities with respect to all organizational stakeholders leads to higher long-term risk-adjusted return.^[87]

RI seeks to control the placing of its investments via several methods:

• Positive selection; where the investor actively selects the companies in which to invest; this can be done either by following a defined set of ESG criteria or by the best-in-class method where a subset of high performing ESG compliant companies is chosen for inclusion in an investment portfolio.
• Activism; strategic voting by shareholders in support of a particular issue, or to bring about change in the governance of the company.
• Engagement; investment funds monitoring the ESG performance of all portfolio companies and leading constructive shareholder engagement dialogues with each company to ensure progress.^[88]
• Consulting role; the larger institutional investors and shareholders tend to be able to engage in what is known as 'quiet diplomacy', with regular meetings with top management in order to exchange information and act as early warning systems for risk and strategic or governance issues.^[89]
• Exclusion; the removal of certain sectors or companies from consideration for investment, based on ESG-specific criteria.
• Integration; the inclusion of ESG risks and opportunities into traditional financial analysis of equity value.

However, in doing so, additional risks are introduced.

• Concentration risk; for example, when compared to the FTSE All-World index, the FTSE4Good Index has an increased weighting towards technology companies^[90]
• Lack of effectiveness in removing some industries; companies specialising in alcohol, tobacco, gambling, defence, AI, cryptocurrencies, oil, gas and coal are all still represented in the main indices^[91]

Several studies have questioned the assumption that increased investment in ESG criteria always contributes to corporate value. Some researchers suggest that excessive investment or over-monitoring of ESG initiatives can not only be ineffective but also counterproductive to a firm's valuation.^[92] In certain cases, overinvestment in ESG by firms or excessive oversight by investors may limit expected benefits.^[93]

In this context, research suggests that the relationship between ESG performance and corporate valuation may be non-linear, exhibiting polynomial characteristics such as inverted U-shaped patterns.^[94] This implies the existence of an optimal level of ESG investment where benefits to corporate valuation are maximised, beyond which diminishing returns or even adverse effects may arise.^[95]

One of the defining marks of the modern investment market is the divergence in the relationship between the firm and its equity investors. Institutional investors have become the key owners of stock—rising from 35% in 1981 to 58% in 2002 in the US^[96] and from 42% in 1963 to 84.7% in 2004 in the UK^[97] and institutions tend to work on a long-term investment strategy. Insurance companies, Mutual Funds and Pension Funds with long-term payout obligations are much more interested in the long term sustainability of their investments than the individual investor looking for short-term gain.^[21] Where a Pension Fund is subject to ERISA, there are legal limitations on the extent to which investment decisions can be based on factors other than maximizing plan participants' economic returns.^[98]

Based on the belief that addressing ESG issues will protect and enhance portfolio returns, responsible investment is rapidly becoming a mainstream concern within the institutional industry. By late 2016, over a third of institutional investors (commonly referred to as LPs) based in Europe and Asia-Pacific said that ESG considerations played a major or primary role in refusing to commit to a private equity fund, while the same is true for a fifth of North American LPs.^[99] In reaction to investor interest in ESG, private equity and other industry trade associations have developed a number of ESG best practices, including a due diligence questionnaire for private fund managers and other asset managers to use before investing in a portfolio company.^[100]

There was a clear acceleration of the institutional shift towards ESG-informed investments in the second semester of 2019. The notion of "SDG Driven Investment" gained further ground amongst pension funds, SWFs and asset managers in the second semester of 2019, notably at the G7 Pensions Roundtable held in Biarritz, 26 August 2019,^[101] and the Business Roundtable held in Washington, DC, on 19 August 2019.^[102]

Networks of institutional investors committed to curbing climate change have emerged, where in institutional investors are agreeing to hold themselves accountable to climate action targets.^[103] One such example is the Institutional Investors Group on Climate Change, looking to deliver significant progress to net zero by 2030.^[104] Moreover, the networks have collaborated with investment frameworks to "evaluate" corporate progress to net zero, with one such framework being the Climate Action 100+, a series of criterion used to evaluate the companies emitting the largest quantity of GHG.^[105]

The Principles for Responsible Investment Initiative (PRI) was established in 2005 by the United Nations Environment Programme Finance Initiative and the UN Global Compact as a framework for improving the analysis of ESG issues in the investment process and to aid companies in the exercise of responsible ownership practices. As of April 2019 there are over 2,350 PRI Signatories.^[106]

The Equator Principles is a risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in project finance. It is primarily intended to provide a minimum standard for due diligence to support responsible risk decision-making.^[107] As of October 2019, 97 adopting financial institutions in 37 countries had officially adopted the Equator Principles,^[108] the majority of international Project Finance debt in emerging and developed markets.^[109] Equator Principles Financial Institutions (EPFIs) commit to not provide loans to projects where the borrower will not or is unable to comply with their respective social and environmental policies and procedures.

The Equator Principles, formally launched in Washington DC on 4 June 2003, were based on existing environmental and social policy frameworks established by the International Finance Corporation. These standards have subsequently been periodically updated into what is commonly known as the International Finance Corporation Performance Standards on social and environmental sustainability and on the World Bank Group Environmental, Health, and Safety Guidelines.^[110]

A company's financial performance represents its overall financial health-in other words, it's used to verify the company's viability and growth potential.^[111] A 2024 study by Susen and Etter demonstrates that higher levels of ESG performance (referred to as ESG Tilt) and changes in ESG performance over time (ESG Momentum) are positively correlated with increased employee satisfaction in S&P 500 companies, mediated by perceptions of organisational justice and expectations of future rewards.^[112] Such intangible factors are presumed to be the missing links between observed ESG performance and the financial outcomes of a company.^[113]

Other studies have shown that integrating ESG criteria into products has an effect on company performance. According to a 2015 study by Fried, Bush & Bassen, there is a positive link, which has been proven in 90% of cases, between ESG performance and financial performance. This positive link can be explained by a reduction in risk exposure. Integrating ESG criteria mitigates potential ESG-related risks. For example, complying with environmental standards avoids certain sanctions that would affect the financial side.^[114] Another study points in the same direction, claiming that publishing sustainability reports improves financial performance,^[115] and reputation, and it leads to the creation of a significant competitive advantage for the company.^[116] In addition, this disclosure is positively associated with return on equity].^[46]

Companies that adopt ESG criteria are more inclined to generate higher profits,^[46] as investors are more oriented towards more ecologically friendly and sustainable products.^[46] These investors are now taking more account of these guidelines in their investment decisions. In other words, the aim of integrating an ESG policy is to have a positive effect on financial performance to cover the costs it generates.

Despite the positive correlation between the inclusions of ESG criteria and financial performance, it does not imply that companies' primary aim is to become socially and environmentally responsible. According to Friedman (1962), "a company's main objective is to increase the wealth of its stakeholders". Furthermore, the ESG hype is a good opportunity for many corporate investors to make money. There are still no universal criteria for assessing whether a fund is ESG or not. Investors rely on ratings to make their investments, but these ratings do not always reflect a complete picture of ESG performance, because they are based on incomplete data supplied by the company itself. Good ESG performances attract and retain investors. Finally, although many studies show a positive relationship between good ESG performance and financial performance, other studies prove that it is difficult to quantify the real financial effect of an improvement in a company's social performance.^[114]

Assigning a precise monetary value to ESG issues is proving complex, if not arduous. Quantitative models and established ESG ratings do not always adequately capture these values, making it difficult to integrate them into investment decisions based on short-term financial data.^[117]

Initially, studies focused on the effect of CSR on financial performance, using models such as the CAPM. Early research, such as that by Alexander and Buchholz in 1978, found no significant link between socially responsible actions and stock market returns. Subsequent studies, such as those by Cochran and Wood in 1984, Aupperle, Carroll and Hatfield in 1985, and Blackburn, Doran and Shrader in 1994, confirmed this lack of correlation between ESG and corporate financial performance, despite differing methodological approaches.

Even when studies have attempted to specifically measure performance about CSR, such as that by Aupperle, Carroll, and, Hatfield in 1985, using risk-adjusted profitability measures, they have reached similar conclusions: the absence of a significant relationship between CSR and corporate profitability.

According to a nationally representative survey from Finder UK, over half (57%) of UK investors hold an ESG investment.^[118] Gen Z being the most likely generation to invest through ESG, with 66% of respondents claiming an interest in ESG investing.^[118] Baby boomers were found to be the least likely to consider an ethical investment, with only 11% of this generation planning to invest in an ethical investment.^[118]

Despite progress, more action is required across industries globally. Sustainable finance emerges within the financial sector as a linchpin, integrating ESG considerations into investment decisions, not merely as an option but as a critical necessity for a just, sustainable, and inclusive future.

Luxembourg exemplifies this shift, with ESG funds reaching EUR 2.8 trillion in assets, comprising around 67.3% of the country's UCITS fund AuM. Most of these funds (59.1%) employ exclusion strategies, targeting sectors like weapons, tobacco, and fossil energy, aligning with responsible investment trends. Notably, ESG Involvement funds focus on sub-strategies like Best-in-Class and SDGs, highlighting their significance.^[119]

However, there is a limited alignment of Luxembourg-based entities with climate initiatives like GFANZ, PCAF, and SBTi, urging broader adoption across sectors to foster sustainability. Simultaneously, stock exchanges play a pivotal role in driving sustainability. They create opportunities for new issuers while safeguarding against greenwashing. LGX's expansion into social and sustainable bonds beyond green bonds reflects the growing interest in aligning environmental and social objectives. Despite Luxembourg's prowess in sovereign ESG scores, corporate ratings tell a different story, especially concerning emissions reduction. This divergence in ratings is pivotal for investors in their decision-making processes.^[120]

While Luxembourg's efforts in sustainable finance are commendable, the journey is in its infancy. Challenges like data availability, standardization, and disclosure persist. Enhancing these aspects is crucial for sector development and measuring progress effectively. Luxembourg's pivotal role in sustainable finance, coupled with its solid expertise and political commitment, has birthed innovative initiatives. The LSFI, integral to this, aims to transition Luxembourg's financial sector sustainably.^[121]

Aligned with Luxembourg's international commitments, the LSFI's Strategy operates on three pillars: Raising Awareness & Promoting, Unleashing Potential, and Measuring Progress. The LSFI's action plan focuses on promoting sustainable finance awareness, sharing knowledge, and establishing a monitoring framework. Developed in collaboration with the government and financial sector representatives, this strategy positions Luxembourg at the forefront of sustainable finance globally, aiming to support the transition of its financial sector towards sustainability as a coordinating entity.^[122]

ESG rating agencies are the main infomediaries of ESG investing. Sustainalytics estimated the number of ESG-rating companies in the ecosystem at over 600 in 2018.^[123]

The ESG rating providers market is going through an increasing trend of concentration. For instance, the data aggregator Morningstar took 40% of Sustainalytics stakes by 2017. Following that, the rating agency Moody’s acquired Vigeo Eiris in 2019, the former leader of European ESG rating agencies. Institutional Shareholder Services( ISS) acquired Germany’s Oekom, while S&P Global acquired the ESG rating business of RobecoSAM. The market's structure is divided between a few very large non-EU providers on one side, and numerous smaller EU providers on the other.^[124]

In this highly concentrated ecosystem, small groups of big index providers, like MSCI, play a pivotal role in setting the standards for what is generally accepted as sustainable finance.

As for categorizing ESG rating agencies by purpose, it is crucial to distinguish between two private ESG rating clusters. First, the ESG risk rating agencies (eg : MSCI, Sustainalytics, S&P, FTSE Russell), they are meant to measure how exposed a company is towards ESG risks -meaning the negative externalities affect the company- more than concrete action on the three factors. Secondly, the ESG effectiveness rating agencies (eg : Refinitiv, Moody s, ECPI, Sensefolio, Inrate) which measures ESG factors commitment, integration and results and therefore outward effect on society.^[125]

This classification is helpful for understanding the confusion around ESG ratings inefficiency in facing the big challenges ahead on the three factors. Indeed, a company with a higher score doesn’t necessarily mean that it has strong environmental, social and governance effect on the world, but rather a low exposure to ESG risks.^[126]

Asset managers and other financial institutions increasingly rely on ESG ratings agencies to assess, measure and compare companies' ESG performance.^[127] More recently, publications like Newsweek have used ESG data provided by market research companies like Statista to rate the most responsible organizations in a country.^[128][129]

Data providers such as ESG Analytics have applied artificial intelligence to rate companies and their commitment to ESG. Each rating agency uses its own set of metrics to measure the level of ESG compliance and there is, at present, no industry-wide set of common standards.^{[citation needed]}

In Latin America, it is the Latin American Quality Institute with headquarters in Panama and operations in 19 countries that leads the movement with more than 10,000 certifications issued.^{[130][131][132]}

The first ten years of the 21st century has seen growth in the ESG defined investment market. Not only do most of the world's big banks have departments and divisions exclusively addressing Responsible Investment but boutique firms specialising in advising and consulting on environmental, social, and governance related investments are proliferating. One of the major aspects of the ESG side of the insurance market which leads to this tendency to proliferation is the essentially subjective nature of the information on which investment selection can be made. By definition ESG data is qualitative; it is non-financial and not readily quantifiable in monetary terms. The investment market has long dealt with these intangibles—such variables as goodwill have been widely accepted as contributing to a company's value. But the ESG intangibles are not only highly subjective they are also particularly difficult to quantify and more importantly verify. A lack of clear standards and transparent monitoring has led to fears that ESG avowals mainly serve purposes of greenwashing and other company public relations objectives, while distracting from more substantive initiatives to improve environment and society.^[133][134]

One of the major issues in the ESG area is disclosure. Environmental risks created by business activities have actual or potential negative effects on air, land, water, ecosystems, and human health. The information on which an investor makes their decisions on a financial level is fairly simply gathered. The company's accounts can be examined, and although the accounting practices of corporate business are coming increasingly into disrepute after a spate of recent financial scandals, the figures are for the most part externally verifiable. With ESG considerations, the practice has been for the company under examination to provide its own figures and disclosures.^[135] These have seldom been externally verified and the lack of universal standards and regulation in the areas of environmental and social practice mean that the measurement of such statistics is subjective to say the least.

One of the solutions put forward to the inherent subjectivity of ESG data is the provision of universally accepted standards for the measurement of ESG factors. Such organizations as the ISO (International Organization for Standardization) provide highly researched and widely accepted standards for many of the areas covered.^[136] Some investment consultancies, such as Probus-Sigma have created methodologies for calculating the ratings for an ESG based Ratings Index that is both based on ISO standards and externally verified,^[137] but the formalization of the acceptance of such standards as the basis for calculating and verifying ESG disclosures is by no means universal.

The corporate governance side of the matter has received rather more in the way of regulation and standardization as there is a longer history of regulation in this area. In 1992 the London Stock Exchange and the Financial Reporting Commission set up the Cadbury Commission to investigate the series of governance failures that had plagued the City of London such as the bankruptcies of BCCI, Polly Peck, and Robert Maxwell's Mirror Group. The conclusions that the commission reached were compiled in 2003 into the Combined Code on Corporate Governance which has been widely accepted (if patchily applied) by the financial world as a benchmark for good governance practices.^[138]

In the interview for Yahoo! Finance Francis Menassa (JAR Capital) says, that "the EU's 2014 Non-Financial Reporting Directive will apply to every country on a national level to implement and requires large companies to disclose non-financial and diversity information. This also includes providing information on how they operate and manage social and environmental challenges. The aim is to help investors, consumers, policy makers, and other stakeholders to evaluate the non-financial performance of large companies. Ultimately, the Directive encourages European companies to develop a responsible approach to business".^[139]

One of the key areas of concern in the discussion as to the reliability of ESG disclosures is the establishment of credible ratings for companies as to ESG performance. The world's financial markets have all leapt to provide ESG relevant ratings indexes, the Dow Jones Sustainability Index, the FTSE4Good Index (which is co-owned by the London Stock Exchange and Financial Times^[140]), Bloomberg ESG data,^{[citation needed]} the MSCI ESG Indices^[141] and the GRESB benchmarks.^[142]

European regulators have introduced concrete rules to deal with the problem of greenwashing.^[143] These include a package of legislative measures arising from the European Commission's Action Plan on Sustainable Finance.^[144]

In March 2021, the U.S. Securities and Exchange Commission (SEC) announced that examination of regulatory compliance related to disclosures for ESG would be an area of focus for the agency in 2021.^{[145][146][147][148]} In the same month, the Employee Benefits Security Administration (EBSA) of the U.S. Labor Department announced that it would review and not enforce a Trump administration final rule for fiduciaries in proxy voting under the Employee Retirement Income Security Act of 1974 (ERISA) to consider pecuniary interests only and not ESG factors in investments for 401(k)s pursuant to Executive Order 13990.^{[149][150][151]} In remarks made by video conference to the European Parliament Committee on Economic and Monetary Affairs in September 2021, SEC Chair Gary Gensler stated that the agency was preparing recommendations for new disclosure requirements for ESG investment funds.^{[list 1]} In October 2021, EBSA proposed reversing the Trump administration ERISA final rule for fiduciaries in proxy voting on ESG investments for 401(k)s.^[157][158]

In November 2021, the SEC rescinded a Trump administration rule issued in 2017 that permitted company managers to exclude ESG proposals from shareholders in annual proxy statements.^{[159][160][161]} In May 2022, the SEC proposed two rules changes to ESG investment fund qualifications to prevent greenwashing marketing practices and to increase disclosure requirements for achieving ESG effects.^{[list 2]} In October 2022, the SEC announced that it would re-open the public comment window for the ESG disclosure rules proposal due to a technical error with the SEC public comment internet submission form.^[168][169] In November 2022, EBSA announced a final rule removing the Trump administration pecuniary interest only requirement for fiduciaries in proxy voting under ERISA when considering ESG investments for 401(k)s.^{[170][171][172]} In March 2023, in the first veto of his administration, U.S. President Joe Biden rejected a bill passed by the 118th United States Congress on party-line votes to overturn the EBSA ERISA 401(k) fiduciary proxy voting rule for ESG investments finalized the previous November.^{[173][174][175][176]}

Under ESG reporting, organizations are required to present data from financial and non-financial sources that shows they are meeting the standards of agencies such as the Sustainability Accounting Standards Board, the Global Reporting Initiative, and the Task Force on Climate-related Financial Disclosures. Data must also be made available to rating agencies and shareholders.^[177]

ESG reporting, which stands for Environmental, Social, and Governance reporting, is when a company shares information about its effect on the environment, society, and how it's governed. This kind of reporting is usually done on a voluntary basis, meaning companies choose to do it to be open and share important information with their stakeholders, including investors.

However, in some places like India and certain regions, there are rules that make ESG reporting a requirement for specific types of companies. For example, in India, there's a regulatory requirement called BRSR (Business Responsibility and Sustainability Reporting) that makes ESG reporting mandatory for the top 1000 companies based on their market value on the stock exchange. They have to provide this report to ensure transparency and disclosure regarding their sustainability and responsibility practices.

The examples and perspective in this section deal primarily with the United States and do not represent a worldwide view of the subject. You may improve this section, discuss the issue on the talk page, or create a new section, as appropriate. (May 2023) (Learn how and when to remove this message)

The Kentucky Bankers Association of 150 banks doing business in Kentucky is suing Kentucky Attorney General Daniel Cameron over his investigating banks' ESG practices, such as commitments to combat climate change.^[178][179] In November 2022, the Kentucky Bankers Association sued Cameron in Franklin Circuit Court; Cameron had the case removed to the US District Court for the Eastern District of Kentucky before Judge Gregory Van Tatenhove, for whom Cameron was previously a law clerk.^{[180][181][182][183]} The association said Cameron has displayed "amazing and disturbing broad overreach" by overstepping his legal authority, and did not have authority to demand detailed information from banks as part of an investigation into their environmental lending practices, which it said was a big government intrusion on private businesses that could create "an ongoing state surveillance system."^{[181][182][183]}

In March 2021, the SEC also announced the creation of a task force to pursue enforcement cases against investment fund managers and public companies for deceptive marketing for ESG investment funds.^[184] In August 2021, the SEC and the Eastern New York U.S. Attorney's Office were reportedly investigating the DWS Group (the asset management division of Deutsche Bank) after its former chief sustainability officer leaked internal emails and company presentations to The Wall Street Journal that showed that the company had overstated its ESG investment efforts.^{[185][186][187]} In December 2021, the U.S. Justice Department informed Deutsche Bank that it may have violated its deferred prosecution agreement from the previous January for failing to inform prosecutors of their former chief sustainability officer's internal complaint about the DWS Group's overstating of its ESG investment efforts.^[188][189]

In March 2022, Deutsche Bank agreed to extend the term of an external compliance monitor until February 2023 from its 2015 settlement with the Justice Department to address its failure to disclose the internal ESG complaint from its former chief sustainability officer the previous August.^[190] In June 2023, the EU commission issued an ESG ratings regulation proposal to guarantee their integrity and transparency. ^[191]

In June 2022, the SEC was reportedly investigating the ESG investment funds of Goldman Sachs for potential greenwashing.^[192] In November 2022, Goldman Sachs agreed to pay $4 million to settle the SEC investigation of the company's ESG funds for greenwashing without admitting or denying guilt of the SEC's allegations.^[193] In February 2023, the SEC Division of Examinations announced that oversight of ESG investment funds would be among six top priorities for the agency in 2023.^[194]

According to a 2021 study done by the NYU Stern Center for Sustainable Business, which looked at over 1,000 studies, "studies use different scores for different companies by different data providers."^[195]

Gallup finds that 28% of U.S. employees strongly agree with the statement, "My organization makes a positive impact on people and the planet."^[196]

Research shows that such intangible assets comprise an increasing percentage of future enterprise value.^[23]

A study published by the European Securities and Markets Authority has also found that "ESG generally improves returns and cuts client costs over time".^[197] Analysis over a five-year period showed stock funds weighted towards ESG scores generally performed higher: an increase in annual average return of 1.59% in European markets, 1.02% in Asia-Pacific markets, and 0.13-0.17% in North American and global markets.^[198]

In January 2023, a Rasmussen opinion poll in the U.S. reported that the proportion of Americans who considered the promotion of "causes like diversity and environmentalism" to be the most important aim for companies was 9%. 69% said that the focus should be on "providing quality goods and services," and 13% on "increasing profit".^[199] A poll by PricewaterhouseCoopers found that "83% of consumers think companies should be actively shaping ESG best practices", with 76% of consumers saying they would "discontinue relations with companies that treat employees, communities and the environment poorly".^[200]

The inclusion of ESG criteria in investment decisions has attracted growing interest in the financial markets. However, this integration of ESG issues faces several major problems, establishing significant barriers to their adoption and accurate assessment.^[201] The inherent complexity of the valuation of ESG criteria, the long-term nature of many of the benefits, and the lack of transparency and standardization in the information available are all significant barriers to the full integration of ESG investments into the financial arena. These challenges call for reforms aimed at normalizing, standardizing, and making more transparent ESG criteria and disclosures to enable more accurate assessment and better decision-making for investors committed to sustainable and socially responsible practices.

Recently, businesses and financial actors claiming sustainability have raised doubts. Greenwashing is a dishonest practice where financial market participants falsely claim sustainability, risking damage to their reputation and potential legal consequences. It can be achieved under different forms such as a mix of despicable environmental management and positive environmental management communication, deceiving investors' and customers' trust in a company's environmental practices. The lack of regulation in the growing financial focus on sustainable development has enabled greenwashing to expand.^[46] Therefore, the European Union developed the Sustainable Finance Disclosure Regulation 2019/2088 (SFDR) in March 2021, which lists characteristics and qualities to differentiate to point out the individuals who support sustainability goals. Moreover, The EU 2020/852 Taxonomy Regulation addresses greenwashing and provides a standardized system for classifying financial goods as sustainable in the EU.^[202] The main source of greenwashing is due to a lack of detailed disclosures about environmental and legal sanctions. It enables one to pretend to be invested in ESG’s practices while having other achievements.^[46]

The landscape of sustainable investments has undergone a significant transformation with the advent of ESG criteria. The rapid evolution of this approach has raised concerns about its increasingly widespread use as a marketing tool.^[203] The absence of regulatory standards governing the communication of this information and the unregulated construction of ESG assessments creates a fertile ground for the exploitation of ESG for marketing purposes. This runs the risk of misleading investors and fund managers while compromising the credibility and relevance of this instrument.^[204]

Furthermore, efforts to meet ESG criteria for sustainability are perceived as a means to attract socially conscious consumers, employees, and investors. In essence, the use of ESG no longer aligns with its original sustainability objectives but has become a marketing tool to attract investors to increase profits. While some studies contemplate potential obsolescence with stricter regulations, it is imperative to reconsider and regulate the use of ESG to restore its credibility and essential role in promoting responsible and sustainable businesses.^[205]

Another major challenge facing ESG-driven investments lies in the apparent conflict between the short-term imperatives of financial markets and the often visible longer-term benefits of ESG initiatives. This imbalance poses major difficulties in evaluating investments and ensuring that ESG issues are properly considered. One of the major problems is the excessive focus of company managers, investors, and analysts on quarterly results, often overshadowing long-term value creation.^[206]

Financial incentives and organizational culture are among the structural factors that fuel this short-term vision. However, ESG issues have a more significant influence on medium- and long-term financial performance, making it difficult to understand them in the context of short-term market expectations. The question of the long-term versus the short-term in ESG investments manifests itself mainly through two crucial points: the temporality of returns and the divergent expectations of investors.

ESG investments often involve fundamental changes in company operations, such as the integration of sustainable technologies or the reconfiguration of human resources management policies. These transformations take time to materialize and do not always produce immediate financial benefits, making them less attractive to short-term-oriented investors. Secondly, traditional investors' expectations of quick returns often conflict with the reality of the more tangible long-term benefits and advantages of ESG investments. This divergence creates a tension between short-term financial objectives and longer-term sustainability imperatives.

A significant criticism in this respect is that financial markets, by focusing on quarterly results, do not encourage long-term-oriented decision-making. This approach can lead to an underestimation of the risks associated with unsustainable long-term practices, compromising corporate sustainability and responsibility. To remedy this, some players advocate reforming financial systems to integrate long-term assessments of ESG investments better. This could encourage companies to adopt more long-term-oriented strategies, rewarding sustainable and responsible initiatives that benefit both society and the environment.

The lack of transparency and standardization remains a major challenge for investors seeking to integrate these aspects into their financial decisions. The limited availability of relevant and timely information is a significant barrier to the proper consideration of ESG issues.

Currently, companies are subject to ESG disclosure requirements, but these reports are not always aligned with regular financial statements. This temporal separation complicates the integration of ESG data into the investment evaluation process.^[207]

The European Union was a pioneer in introducing ESG requirements, such as the European Directive on Non-Financial Disclosures and Diversity, which initially applied to large companies. More recently, the proposed revision of this directive extended its scope to all large, listed companies. However, despite these regulatory advances, a lack of transparency persists in ESG investments. Nevertheless, the problems associated with this lack of transparency are manifold. Firstly, the absence of clear global standards creates variability in ESG reporting. Companies have considerable leeway in choosing which criteria to disclose, leading to heterogeneity in reporting and making it difficult to compare the ESG performance of different entities. In addition, the disparity in the indicators used makes it difficult to understand actual sustainability and social responsibility performance.^[47]

This variability and lack of consistency in ESG reporting is fuelling significant criticism, investor confusion and mistrust. In the absence of uniform standards and standardized reporting, some capital market participants find it difficult to accurately assess companies' ESG performance, risking investment decisions based on incomplete or potentially misleading information. Moreover, this can open the door to greenwashing, where companies embellish their environmental or social practices to appear more responsible, without implementing them.

ESG guidelines among western European arms manufacturers have been criticised for compromising on practical battlefield durability over environmentally-friendly manufacturing practices. During the Russo-Ukrainian War, military weaponry and equipment supplied to the Armed Forces of Ukraine by western European countries containing electronic components with cable insulation made from corn fibre in place of synthetic insulators have succumbed to malfunction due to damage caused by rodents.^[208][209]

Bundled references