The second wave of corporate sustainability and the standardization of ESG funds

Recently, however, ESG practices have been collecting critics, which has forced a reflection on the imperfections of the financial services sector because the overall increase in ESG investments has not been accompanied by the establishment of the infrastructure to support them.

However, much of the criticism ignores emerging initiatives to address its shortcomings. Indeed, a second wave of corporate sustainability and sustainable finance - ESG 2.0 - is beginning to gain traction.

"What is an ESG fund? Honestly, nobody knows - and that leads to greenwashing and impunity. But ESG critics neglect to mention that regulators are transitioning to best practice guides or standards based disclosure and adopting rules-based criteria to determine what an ESG fund is," says Rodrigo Tavares, professor at Nova School of Business & Economics (Nova SBE) and responsible for the initiative to classify this new paradigm of the capital market, initiated by the UK government, the City of London and the British Standards Institution (BSI), in a article published in Fortune.

The professor explained that in December 2021, the Brazilian organization ANBIMA was the first in the world to establish prerequisites for businesses to label their funds or products as "sustainable." The same is already underway in the UK. When ESG fund standards are properly adopted and when there is a deeper level of knowledge on the subject, regulators will finally be able to combat greenwashing.

"As we move forward, ESG is gradually being split in two: On one hand, financial products that integrate ESG policies, data, and practices, with the aim of identifying new financial risks and unlocking opportunities for value creation; and on the other hand, funds that intentionally generate positive social or environmental impact and are therefore aligned with moral values.

While the first type could potentially invest in oil and gas companies (assuming that ESG risks are properly integrated into valuation methodologies), the second is only meant to advance the Sustainable Development Goals," adds Rodrigo Tavares.

However, there is a dataproblem associated with these funds. There are more than 100 rating agencies operating in an unregulated manner or with a lack of transparency.

"However, we are rapidly heading towards market consolidation with several larger companies buying out smaller ones. Soon, S&P, Moody’s, and Fitch will likely dominate the market and incorporate data, which is currently in the hands of ESG risk rating agencies, into their own credit ratings. At the same time, a handful of independent agencies that measure the impact of companies’ products and services will likely survive. For both, a focus on the most material ESG issues according to industry, geography, or company size is fundamental. Academic research is also working hand in hand with the industry to perfect existing materiality frameworks."

"Finally, we must standardize companies’ sustainability reporting," he concludes, noting that these documents can often take into account 30 different metrics, and that this multiplicity adulterates compatibility between companies.

However, this point may no longer be an inevitability in the coming years as the International Sustainability Standards Board (ISSB), announced at COP26 in 2021, is being developed to ensure a universal standard for ESG.