With the EU struggling to nail down ESG benchmarks, how investors can ensure impact

SME Publications/ SME XPO 2024

By Brondwyn Douglas, below, ESG specialist, Spear Capital

The European Union has long been a global leader when it comes to setting the legislative and regulatory framework for sustainable investing. But even it has faced struggles when it comes to benchmarking for Environmental, Social, and Governance (ESG)-based investing. Earlier this year, for instance, it had to put a key plank of its ESG rulebook on hold amidst political infighting.

That kind of uncertainty isn’t helpful, especially as a growing number of voices question the value of ESG. Opposition to the investment philosophy covers a broad spectrum from right-wing extremists (particularly in the US) who believe that it’s a left-wing plot to impose a radical agenda, through to those in the middle (such as The Economist) who believe current measures are too complex, to those who think that ESG has been used for mass greenwashing by some of the planet’s biggest corporations.

While ESG has proven resilient in the face of those attacks and global investment pullbacks, it’s an inescapable fact that it’s long had a measurement problem. Knowing that, what should investors who are looking to ensure a positive impact do?

Take the good from what’s already there

As difficult as some of the processes around the EU’s ESG benchmarking have been, it’s still produced some worthwhile results. The same advisers who’ve warned the UK not to adopt some of its measures, for instance, have said it should still regard EU taxonomy as a general template.

The efforts by political and economic blocs such as the EU to establish ESG benchmarks are important because they could remove a lot of the existing uncertainty in the space. It’s estimated that there are currently 140 ESG data providers in the market. Those providers range from the ESG branches of high-profile agencies such as Moody’s, S&P, and Morgan Stanley to smaller, independent players. While there are commonalities in many of those ratings, it’s still all too easy for the same company to get significantly different ratings from different agencies.

The existing benchmarks set out by the EU provide a baseline that should, in time, bring those ratings more in line with each other. It should also be noted that the EU will keep building on its existing benchmarks. Earlier this year, for example, its financial regulator, the ESMA, expressed support for bids to set regulatory benchmarks in addition to the current disclosure requirements it has set out.

Such a measure, the financial regulator said, “is key to ensuring a quality label, and a high level of consumer and investor protection.”

“In addition,” it added, “the creation of such an EU ESG label should consider sufficiently ambitious minimum standards for the methodology which would offer reassurances as to the sustainability-related impact of such benchmarks.”

Getting ahead of the game

There is no reason that investors can’t use the existing and proposed EU benchmarks to measure how their portfolio companies are doing from an ESG perspective. In doing so, they would likely be putting themselves ahead of the game. After all, just as the EU leads the world when it comes to data protection and privacy (most notably in the shape of its General Data Protection Regulation), it looks likely to be a leader in ESG benchmarks and regulations. As such, any investor looking to ensure ESG impact could do a lot worse than to follow its example.

Keep it focussed 

Of course, there are other ways investors can ensure impact. One way is to steer clear of investment into big corporations, however compelling their ESG positions might seem, and focus on SMEs where impact measurements can be more focused.

It’s a philosophy that we view as key to our operations at Spear Capital and which is especially important in the Southern African region, where SMEs play an outsized role. In South Africa, for instance, SMEs represent 98% of businesses and employ 50 to 60 percent of the country’s workforce across all sectors.

Making the most of momentum

Ultimately, for all the debate around the effectiveness of ESG in recent months, it’s important to remember that it’s still a relatively new and evolving concept. What seems important now might not be in a few months.

But investors shouldn’t wait for that evolution to get to a point that they’re comfortable with. Instead, they should use the tools available to them right now to build momentum and keep growing within an ESG framework towards positive impact.

SME Publications/ SME XPO 2024