Amidst Criticism, ESG Reporting Should Be Reformed, Not Abandoned

ESG reporting is the new arm of corporate social responsibility (CSR), and in an attempt to crack the S&P 500 ESG, some companies are catching the ire of the U.S. SEC (Securities and Exchange Commission).

Is that confusing? That’s one of the problems with environmental, social, and governance (ESG) reporting. Ambiguous language, confusing acronyms and unclear definitions detract from the insight that the metric is meant to provide. 

Academics and business executives question the effectiveness and morality of ESG reporting, often by citing its lack of consistency. Perhaps most notable among them was Elon Musk when he tweeted, “ESG is a scam.” Musk made the claim after his electric vehicle company Tesla was pulled from the S&P 500 ESG Index.

EY’s global vice chair of sustainability, Steve Varley, is a proponent of ESG reporting and investing, but he admits that “more work must be done to encourage open collaboration and trust-building among those who shape the industry.”

In order to maintain the progress made in sustainability reporting, EY (long known as Ernst & Young) has commissioned a new report on how to strengthen ESG ratings.

What’s wrong with current ESG reporting?

To appeal to consumers and investors, companies want to share publicly that they are responsible corporate citizens who care for the environment and important social causes. Without a regulated standard for ESG reporting, however, companies are essentially free to claim what they want. What counts as “green initiatives” or “social progress” is up to the company.

Consumers and investors want to support sustainable brands, but this creates an incentive for companies to greenwash and undermines the value of ESG reporting.

In response, the SEC created a Climate and ESG Task Force in March 2021 to investigate companies’ ESG claims. In May 2022, it issued its first enforcement action against the NYSE-listed Brazilian mining company, Vale S.A. The task force found that Vale made false claims and misled stakeholders about the safety of its dams, one of which collapsed and killed at least 259 people.

The SEC task force is a step in the right direction, but the commission’s jurisdiction is limited to publicly traded companies in the United States. ESG is a global concern, and better independent oversight, or assurance, is needed.

“About half of the world’s largest companies have assurance over their sustainability disclosures, though the significant majority are obtaining “limited” rather than “reasonable” assurance on a par with what is provided over financial reporting,” says Marie-Laure Delaure, who leads EY’s assurance practice.

How to improve ESG reporting

In response to the growing criticism of the rating system, EY released a new report on the state of ESG and recommended five actions to strengthen the credibility of the metric.

The report recommends more transparency over ESG ratings, increasing understanding of the varying uses of sustainability information, putting in place conditions that enable assurance, developing comparable and interoperable taxonomies, and addressing the barriers faced by market participants in emerging countries.

According to Varley, “ESG is facing a make-or-break moment and requires a whole system approach to addressing these issues.”

Acting on these recommendations would remove a lot of the grey area in ESG reporting and make it easier for investors and consumers to support truly sustainable businesses.

Why is ESG important?

Financial growth is vital to maintaining a strong economy, but positive economic performance should not come at the cost of a deteriorating environment or violating human rights.

We want to know that companies are acting in good faith.

“According to the most recent EY Global Institutional Investor Survey, 89 percent of investors surveyed said they would like the reporting of ESG performance, measured against a set of globally consistent standards, to become a mandatory requirement,” says Varley.

Before it can become mandatory, however, the ESG rating system requires vast improvements, global cooperation and regulatory oversight.

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