The executive trying to clean up sustainable investing

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Steve Varley thinks environmental, social and governance investing is at a tipping point.

ESG investment is the fastest-growing asset category but it is also murky and rife with misrepresentation. As global vice chair for sustainability at accounting firm EY, Varley wants to fix the flaws before it loses credibility.

EY put out a report last week pointing out that there’s often a mismatch between investors’ aims and what ESG scores are measuring: While investors are often trying to make a positive impact, ratings firms are mostly focused on evaluating companies’ risk exposure to environmental, social and governance factors rather than their impact on society.

By calling attention to the shortcomings, Varley is trying to “make sure that fad doesn’t explode, because at its heart, it’s really trying to do something that’s worthy.”

This interview has been edited for length and clarity.

It sounds like what you’re saying in this report that ESG is rife with BS claims, but it’s the best we have. And so we should improve it rather than throw it out with the bathwater?

I think it’s been well-applied as a risk management framework within a company. And then what’s happened over time is it’s been used more and more by financial companies to market their products and services. And I think that it’s quite hard for investors and financial professionals to really understand what that means.

If you’re an investor, and you’re trying to make a difference in your contribution to reducing the climate emergency, one of the things that we’ve worked out from looking at the ESG composites is an average of only 15 percent of your $1 investment would make a difference to climate, if you put your money into what’s called ESG.

The point we’re trying to make in the report is that ESG is sort of the best we have at the moment, but it does need to go through an upgrade, an evolution. There are some things it’s probably not destined to be and there’s some things it does rather well. There’s some crossroads coming up for ESG. We overall think it’s a good thing, but it could be captured and misunderstood in many areas.

You talk in the report about how millennials and Gen Z want to invest in ESG products. Do you think that ESG commitments are a good way to win their trust? It seems like if they’re interested in sustainability, they would also be distrusting of business.

I go back to my data on only 15 percent of money applied into ESG goes towards something that’s got a positive climate action. It might be that a lot of Gen Z, and even Millennials, when they put that dollar into an ESG fund, they may have an automatic assumption that dollar’s all going into climate. But actually, less than one in six of those funds will have a positive impact on climate.

I think if we don’t get better at explaining to those investors where their money’s really going, then there’s an opportunity for disappointment and accusations of greenwashing and then a loss of trust for that generation in particular.

How much of an obstacle are the political attacks on ESG? How far does that go towards hurting its legitimacy? 

I’ll try and take a positive from it: that a heightened level of awareness and discussion on what ESG is and what it isn’t and how it’s used is going to be a good thing. As long as together we can evolve ESG so it does meet its potential.

ESG at its heart is a very well-meaning frame so that investors can put their money into something that gets a good return and does well across environmental and social aspects. That’s going to be a good thing for us to debate more and more: What does that mean? How do we use it? What are the good things about it? What are the bad things?

I’ve always understood well the E and the S. I think the G is a strange third bedfellow. That’s back to its roots again in a risk framework, where you would look at a company you’re about to invest in, and it would just be their environmental risks, their social risks, and the way they govern the business.

From the risk perspective, the trilogy of letters works, but now it’s been applied to defining whether investments are good or not. I struggle a little bit on whether G, governance, is an impact outcome I want for my dollar to go in. I can get it on an S. But G, I’m not so sure. That’s one of the points where it kind of fails a bit.

How do you think ESG will fare in an economic downturn? Do you think that it will persist? Or do you think it’s the kind of thing that will fall off if either investors or consumers start demanding either cheaper goods or better returns?

I think ESG becomes even more important if we’re headed towards a recessionary environment or global downturn. I think the pressures on us in society in a recession are amplified. And I think it’d be really wrong for business to move back to older habits of shorter-term focus, [and] their horizons drop back to just looking at financial returns. I think that would be a mistake, and I think we’ve done that in the past, and I think we and businesses suffered from a loss of trust.

I thought it was quite an interesting fact that 70 percent [of investors] are saying they want a social impact. I think that’s a lot higher than maybe a few years ago. Let’s hope that doesn’t decrease due to recession, and people don’t fall back to, ‘I just need a short-term dollar.’ I think that would be a problem.

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