Time to Rethink ESG?

As widely reported, the tidal wave of environmental, social and governance (ESG) messaging that began permeating corporate America in 2020 has receded this year.

ESG-related rulemaking and enforcement activity from the Securities and Exchange Commission aimed at “greenwashing” is likely partly to blame, as is the severe politicization of ESG investing that intensified in the summer of 2022 when the attorneys general of 19 states asserted publicly that the “net zero” carbon emissions initiatives pursued by the world’s largest asset manager lowered investor returns and represented a failure of fiduciary duty. So-called “anti-woke” state-level legislation and similar campaigns followed, including some aimed at preventing insurers from considering ESG matters in underwriting policies.

With these opposing positions dividing ESG discourse in the United States today, it is perhaps not surprising that, across sectors, companies have dialed back their ESG messaging and that insurers and boards of directors are increasingly wary of ESG-related litigation and regulatory risks.

At the same time, ESG topics remain vitally important to employees, customers, investors and other key corporate stakeholders. For example, a 2022 study from Stanford Business School shows that climate change and diversity, equity and inclusion (DE&I) issues remain central to the investment and other decisions of Generation X, millennials and Generation Z. These generations incorporate ESG investment objectives at high rates and are generally willing to pay and risk more to do so. Of course, insurers in their underwriting and investment activities, as well as corporate pension plans, family offices and other institutional investors, began focusing on ESG factors long before the label emerged. Indeed, by all accounts, trillions of dollars are committed globally to ESG strategies.

Still, ambiguity about the meaning and purpose of ESG persists. A lack of standardized corporate ESG data hobbles meaningful comparisons of ESG statistics, initiatives and strategies and has heightened the concerns of regulators and the risks faced by insurers and companies. Since the spring of 2022, the SEC has:

• Proposed rules to standardize climate-related disclosures for public companies, including disclosure regarding the actual or likely material impacts of companies’ climate-related risks on their business, strategy and outlook; the oversight and governance of climate-related risks by board and management; and companies’ greenhouse gas emissions
• Proposed rules “to create a consistent, comparable and decision-useful” disclosure framework for investment funds and advisors
• Publicized enforcement settlements with public companies and investment firms on claims of greenwashing
• Adopted amendments to the names rule for mutual funds, ETFs and other registered funds styled as “enhancements to prevent misleading or deceptive investment fund names.”

Some funds have removed ESG terminology from their names following the names rule changes. But with the other SEC rule proposals hanging in the balance, many companies continue to have substantial risk exposure from their voluntary reporting on ESG topics in public filings, offerings and marketing materials and from their reports to investors and ESG framework sponsors like the UN Principles for Responsible Investing.

Insurers are thus plagued not just by the manifest risk of massive claims arising from weather-related catastrophic disasters but also by the increasing risk of claims arising from regulatory violations and litigation brought by activist shareholders. Accordingly, calls have come for a stepping back and a rethinking of ESG in America today.

Here is a potential framework for how insurers and other stakeholders might begin the dialogue.

E: Should it be C? Outlets on both sides of the political aisle report that climate change is a top issue for younger voters. Carbon neutral and similar climate pledges are highlighted across corporate websites. Climate-related risks are the primary focus of the majority of insurers that have folded ESG into their underwriting processes. Asset manager ESG strategies typically focus on the financial materiality of climate change on business operations, seek to reduce corporate carbon output, and/or screen out fossil fuel companies. In other words, while the E in ESG sometimes relates to environmental concerns beyond climate, such as protection of endangered species, the E most often refers to carbon emissions and other climate-related matters. Should, then, our E really be a C? Would a change in nomenclature, from E to C, narrow the discussion and foster greater transparency, consistency and comparability? Could it reduce the risk of greenwashing?

Social (Security?) The S in ESG has been somewhat of a catchall for the many aspects of business that impact employees and the broader social environment. Pay equity and other DE&I matters, along with human rights and workplace and product safety topics fit clearly here. In response to concerns about violence at home and abroad, though, calls have come to expand the scope of social, or S, factors to explicitly include, broadly, the social security impact of a company’s operations. That is, investors and other stakeholders are asking how corporate policies, practices and relationships protect or imperil the social institutions that afford safety to communities inside and outside the corporate environment. What obstacles might stand in the way of collecting and comparing this type of corporate security data? What additional light might such data shed on a company’s supply chain and distribution connections, for example?

The Presumptive G. Assessing the strength of a company’s governance—its policies, procedures and other controls designed to further the best interests of the company and its shareholders—has long been among the most basic aspects of investment and underwriting due diligence. Is the association of fundamental governance factors with emerging environmental and social factors necessary? Is it appropriate? Should the G in ESG be refocused on governance matters relating exclusively to environmental and social matters? Could this enhanced transparency reduce overall risk exposure and/or enhance risk management strategies?

The universe of potential responses to these questions is as wide as the ESG ocean itself. As both ESG advocates and anti-ESG factions pursue their respective agendas, maintaining a flexible mindset and being willing to tackle hard questions should serve insurers and other ESG stakeholders well.