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ESG credibility under threat from lack of standardization, report warns

ESG

ESG needs regulation. Image courtesy of BusinessGreen via iStock.

A lack of standardization, regulation and common purpose risks opening the door to "greenwashing" in the financial sector that could undermine the burgeoning environmental, social and governance (ESG) investment movement, a new report from EY and Oxford Analytica has warned.

The influential consultancy and analyst firms teamed up on new research which seeks to provide insights into the challenges facing the ESG movement, which they warn are being compounded by rising inflation and the war in Ukraine.

The report, published last month, warns that allegations of greenwashing have become a major barrier to the continued success of the ESG sector, which has seen a boom in investment in recent years but has been dogged by allegations that too many nominally green ESG funds continue to invest in high carbon or environmentally damaging businesses.

In order to build trust and gain credibility, the report recommends ESG scores should treated on an equal footing alongside other considerations in the more established ecosystem of financial reporting.

The report also contends that the sector continues to be hampered by a lack of agreement on what ESG funds should include, how agreed metrics should be applied, and how available data should be used.

Sustainable finance taxonomies should be developed to help avoid confusion over what is considered 'sustainable.'

The report argues there is an urgent need for increased transparency over how ESG ratings are calculated, increased understanding of the varying uses of sustainability information, and more independent assurance around ESG scores, alongside enhanced reporting standards. It also advises that sustainable finance taxonomies should be developed to help avoid confusion over what is considered "sustainable", while ensuring lower barriers to entry for those firms from emerging economies.

"The extraordinary growth of the ESG movement is threatened by a lack of alignment and agreement on foundational concepts and, in worst cases, growing claims of greenwashing," said Steve Varley, EY's global vice chair of sustainability. "Right now, ESG is facing a make-or-break moment and requires a whole system approach to addressing these issues. Sustainability is everybody's business and more work must be done to encourage open collaboration and trust-building among those who shape the industry." 

The report notes that while there are increasing connections between ESG and financial reporting, there is a need for greater engagement with civil society and other interested parties to develop reporting and disclosure standards, sustainable finance taxonomies, and ESG ratings.

"Many of the current challenges facing ESG are [because it is] a product of its infancy," added Katie Kummer, EY's global deputy vice chair of public policy. "The sustainability ecosystem is just more than 20 years old, and so still in its maturing stage compared to the financial reporting ecosystem. It is essential that we work together to build a system that is globally consistent, trusted, responsive and where everyone has a voice."

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