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The inventors of ESG: ‘Critics have a point—here’s the new global reporting system that will address it’

October 18, 2022, 12:01 PM UTC
A firefighter battles a brush fire on June 17 in California’s Jurupa Valley.
Qian Weizhong—VCG/Getty Images

Environment, social and governance (ESG) reporting is undergoing its biggest stress test since the concept was first coined by the UN Global Compact (UNGC) in 2005, during the tenure of late United Nations Secretary-General Kofi Annan. The concept is under fire from a growing chorus of critics, who argue that ESG is a pointless distraction in a world riven by conflict, energy shortages, rising inflation, and the threat of recession.

No idea is worth its salt unless it can withstand scrutiny–and critics have a point. We are losing ground on a long list of indicators–carbon emissions, absolute levels of poverty, basic healthcare, access to clean and affordable energy, the preservation of our natural environment. This despite a boom in ESG-labeled investment products, which will likely be worth an astonishing $41 trillion by the end of this year, according to industry estimates. That’s almost one-third of global managed funds.

It is time to acknowledge that on a broad range of issues, from runaway climate change to widening social and economic inequalities, our actions do not match the ambition and pace needed to achieve the UN’s Sustainable Development Goals (SDGs) by 2030. It’s also important to admit that the 17 SDGs sometimes present difficult choices for governments. Will Europe burn more coal this winter to heat homes? And how will this affect the continent’s aim to slash emissions by 55% by 2030?

While the goals embedded in the initials ESG may not always align with each other, the core reasoning behind the interconnectedness of ESG remains sound–and it’s more relevant today than it was 20 years ago. Back then, the UN Global Compact’s seminal report Who Cares Wins argued that companies and financial institutions could significantly enhance their performance and create more value for shareholders if they became better at managing a broad range of environmental, social and governance risks.

By these measures, ESG is succeeding. On the risk management side, at least, the evidence shows ESG works. Of more than 2,000 academic studies, according to management consultants McKinsey, around 70% found a positive correlation between ESG scores and financial returns–whether measured by equity returns, profitability, or valuation multiples. Increasingly, too, companies with good ESG frameworks are being rewarded with lower borrowing costs. Lenders reason that companies with healthy ESG scores have better governance and risk management processes, and therefore represent a lower lending risk.

The UN also had an underlying motive in rallying businesses to ESG: the expectation that well-run companies respectful of UN Principles would make a fundamental contribution to sustainable development.

For a while now, the UNGC, the world’s largest corporate sustainability initiative, has been urging companies to adopt measurable goals and targets. Stakeholders are increasingly skeptical of wooly goals and misleading claims. In Europe, regulators have struck off 1,000 European funds from the sustainable universe after imposing stricter rules to define what can be labeled a sustainable fund.

The UN Global Compact’s 15,000 members in 161 countries have already pledged to uphold the UN Ten Principles on human rights, labor, environment, and the fight against corruption, and to take action to advance social development. Now we are asking them to demonstrate tangible progress on these commitments by reporting to our new enhanced and digitized Communication on Progress reports. They will be asked to leave if they fail to show progress. We do not want the UNGC to be a soft touch for greenwashers.

The advantages of making real progress on ESG are manifold. Companies can build credibility and brand value by showing their commitment to the Ten Principles and the Sustainable Development Goals. The reports will measure and demonstrate progress to stakeholders in a consistent and harmonized way. The system will enable our members to assess themselves against their peers and learn from each other. The UNGC will be able to learn from the feedback it gets to assess and track by industry, sector, and principle area. The new enhanced system goes live early next year.

ESG belongs in the real world–with its advances, setbacks, messiness, difficult choices, and balancing acts. COVID, climate change, conflicts, and their many repercussions have shown that ESG is by no means perfect–but it is still the best way we have found to gauge the progress and impact of our corporate citizens.

Sanda Ojiambo is the assistant secretary-general, executive director, and CEO of the UN Global Compact.

The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.

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