Ethical investing: Where are we now on ESG?

With the world facing mounting environmental threats and yawning inequality, a growing number of consumers and investors are pushing business to prioritise the planet and people as well as profits.

Be it diversity goals or climate targets, companies are increasingly keen to trumpet their performance on environmental, social and governance issues - or ESG.

Sustainable investing has boomed, reaching $35.3 trillion by the start of 2020 – a 55% increase since 2016, according to the Global Sustainable Investment Alliance (GSIA).

But there are major concerns over 'greenwashing' - where companies and funds overegg their sustainability credentials or make unverified claims - as well as a lack of clear criteria to measure and compare ESG performance.

Tech mogul Elon Musk last year blasted ESG assessments as a "scam ... weaponised by phoney social justice warriors" after his electric vehicle company Tesla was temporarily dropped from a widely followed ESG index.

Here is a look at the changing landscape.

What is ESG?

ESG is a broad term which aims to capture how companies are performing across a wide range of environmental, ethical and transparency criteria - from their greenhouse gas emissions to their labour practices.

Companies tend to focus more on the 'E' - or environmental - aspect of ESG because of the global attention on climate change and because it is easier to produce metrics.

But the COVID-19 pandemic, the booming gig economy, emerging regulation and movements like Black Lives Matter have sharpened focus on the social aspect of ESG, which encompasses how companies treat their staff and the communities they operate in.

ESG proponents say paying attention to the 'S' is not just about ethics but also makes good business sense. For example, poor treatment of workers may lose a company customers and reduce productivity.

"Social factors can strongly influence and underpin the long-term value of a company," said James Alexander, chair of GSIA and chief executive of UKSIF, which promotes sustainable finance in Britain.

Despite the buzz around ESG, not everyone is on board. In the U.S., Republican politicians have attacked it as encouraging the "proliferation of woke ideology".

Others argue ESG is simply too broad and muddled, and the E should be spun off from the S and G.

How do you measure ESG impact?

It is a major challenge. Some aspects such as a company's carbon emissions can be gauged and compared, while social factors are often harder to pin down.

One huge problem is the lack of regulation.

Companies have for years been able to make public declarations on their ESG commitments without being held to account.

This has led to charges of 'greenwashing', making it hard for investors to know where to put their cash.

Investors often rely on external rating agencies which score companies on their ESG performance, but many experts in the sector say even these do not give a clear picture.

Why have ESG ratings attracted criticism?

The rating agencies aggregate hundreds of metrics which they boil down to one score. But they employ different and opaque methodologies that often yield widely varying scores for the same company.

Some of the discrepancy is down to the inclusion of incomplete and unverified data.

Experts say there is an urgent need for more transparency and regulation, with some critics dismissing ESG ratings as meaningless.

There is also disagreement over what ESG ratings should measure.

Contrary to what many might assume, the scores do not reflect how much companies are doing to address social and environmental challenges, but how much risk they face to their bottom line from ESG factors.

Some, like Musk, believe they should reward companies that do the most for the planet and society.

How might new 'ESG 2.0' rules make the picture clearer?

Tighter rules to counter greenwashing are on the way.

The European Union has taken the lead with its Corporate Sustainability Reporting Directive enacted in January, which is seen as a game changer.

Under the new rules, large and listed companies have to publish annual reports not only on the social and environmental risks they face, but also on how their activities impact people and the environment.

Companies' ESG data will also have to be externally audited, which regulators say is crucial for giving investors reliable information.

Dozens of other jurisdictions including the United Kingdom, the U.S., Japan, India, the African Union and Australia are also bringing in ESG regulation requiring mandatory disclosures.

Most have started with disclosures focused on the E component with commitments to extend to S and G.

The new era has been dubbed ESG 2.0.

"ESG 1.0 was completely unregulated allowing companies to cherry pick what they wanted you to see. It was no more than a marketing tool," said Marc Lepere, an expert on ESG at King's Business School, King's College London.

"ESG 2.0 introduces mandatory disclosures aimed at ensuring sustainability data is as accurate and consistent as financial data. It's a completely different world."

(Reporting by Emma Batha; Editing by Sonia Elks.)