ESG: Earth’s Salvation or Greenwash du Jour?

The second I read the headline, I knew exactly what the article was going to be about. And indeed, “One of the Hottest Trends in the World of Investing Is a Sham,” a New York Times op-ed by New York University associate professor Hans Taparia, slams ESG ratings (short for environmental, social, and governance) as a big, fat corporate scam.

In his damning argument, Taparia points out that the sustainability rating agencies that score ESG funds, “contrary to the spirit of ESG investing (and likely unknown to most investors),” are actually just “measuring how much potential harm ESG factors like carbon emissions have on companies’ financial performance” instead of benchmarking their environmental and social performance against some kind of independent ESG standard. As a result, 90% of all stocks are part of ESG funds, and companies like McDonalds, Coca-Cola, and even Exxon, receive “respectable” ratings, Taparia writes.

This wasn’t the first time I’d read about ESG being the latest, and an unprecedentedly powerful, greenwashing platform. Joel Makower at GreenBiz has written an eye-opening three-part series on the topic, and he told me in an interview that others have been sounding the alarm for years without getting much of an audience.

That might be starting to change. The question is, though, what are we going to do about it?  (For the impatient, click here to jump to the conclusion.) 

A better world … for investors?

“A significant number of people assume that a highly rated company on ESG metrics is a ‘good company’ on the journey to sustainability in some fashion,” Makower told me. But “what ESG ratings measure, pure and simple, is risk”—specifically financial risk. Because of this, “companies can be doing a lot of really bad things and still be highly rated,” Makower pointed out.

“The industry has done a lot to perpetuate this, even though some of the ratings firms will say, ‘We’re very clear about what this is and isn’t,’” Makower continued. The upshot is that highly rated companies aren’t necessarily creating a better world, he says—“unless you define a better world simply as one in which investors earn more money.” Ouch.

Reporting vs. ratings

Before we go further, it is worth understanding the difference between ESG reporting and ESG ratings.

The reporting is done—usually voluntarily and usually without any kind of third-party review—by the companies themselves, typically based on standards developed by the Global Reporting Initiative (GRI), the Sustainable Accounting Standards Board (SASB), or other nonprofits. These standards basically just list which metrics companies should track and disclose, John Mandyck, CEO at Urban Green Council, explained to me. Although certain measures have pretty obvious sustainability implications, the standards don’t define what counts as good or bad performance.

“A significant number of people assume that a highly rated company on ESG metrics is a ‘good company’ on the journey to sustainability in some fashion.” –Joel Makower, GreenBiz

Performance scores are, instead, left to ESG rating agencies like Sustainalytics and MSCI, which collect data from companies’ publicly available ESG reports and use proprietary methodologies to decide who’s doing well and who’s doing poorly, said Mandyck.

Finally, there are the outlets that publish these scores. Something exploded in the U.S., Mandyck said, when one big player—Yahoo! Finance—became one of those publishing outlets. Alongside the standard financial results required in U.S. Securities and Exchange Commission (SEC) filings for each publicly traded company, “at the end of the list, there’s a sustainability tab reporting the Sustainalytics score.” When that started, Mandyck claimed, “Every CEO in America said, ‘What is ESG?!’ All of a sudden it was mass media, and everybody could see it—competitors, investors, employees.”  

ESG reporting, ratings, and rating publishing are “complex, and there’s a lot of criticism in each of those stages,” Mandyck noted.

Some programs work differently

Two organizations I’ve looked into break out of this three-stage model—and one of them, GRESB (Global Real Estate Sustainability Benchmark), is the ESG framework for the real estate industry. (Disclosure: my husband used to work on the GRESB software through his employer, Green River, which is no longer the developer.) The other, CDP (formerly the Carbon Disclosure Project), can be used by any company but focuses exclusively on climate change, deforestation, and water security.

Both of these programs combine an online ESG survey platform with a performance scoring system. So when you enter your organization’s ESG information into the GRESB survey, those data ultimately get benchmarked against data from peer organizations in the same investment sector. The focus is on environmental and social performance, like energy efficiency, green building certification uptake within the portfolio, and tenant health and well-being—not primarily on financial risk, though financial risk management is indeed a factor in the governance section of the survey.

CDP works similarly, collecting performance data (with perhaps a greater emphasis than GRESB has on financial risk management), and then highlighting top performers in published “A Lists” in each performance category.

ESG is not sustainability

Still, the entire goal of ESG reporting and rating is to help investors make more money. In the real estate industry, there is longstanding evidence that environmental performance correlates with financial performance, so GRESB can afford to focus more on the former, but the true goal is still to signal to investors that a company or fund is a good financial bet.

“ESG is in crisis right now” for this very reason, according to Chris Pyke, Ph.D., senior vice president for product at ArcSkoru, a for-profit affiliate of the U.S. Green Building Council (USGBC). “Didn’t we think that ESG was going to yield sustainability?” he asks. “But it wasn’t a replacement. It was a different idea that could be used to promote sustainability.” Now, Pyke says, there’s a “growing realization that they’re not synonymous in practice.”

Are we overthinking this?

At the same time—yes, this is purely anecdotal, and I work in the sustainability space—everyone I’ve met who works in the ESG realm is genuinely trying to make the world a better place. Admittedly, none of these people are investors. But, ratings and scores aside, ESG commitments and reporting probably do have the potential to change the way companies do business.

“Folks will criticize anything and everything,” said Nicole DeNamur, Hon. AIA, an attorney and the owner and founder of Sustainable Strategies. “There are valid criticisms of ESG because it is so nascent and so ripe for abuse.” But maybe we’re asking for too much, too early, she suggested. LEED and WELL, for example, which have always gotten plenty of criticism, “never purported to be perfect; they are just trying to move the market.”

 “The world is on fire. Let’s do something.” –Nicole DeNamur, Sustainable Strategies

DeNamur conceded that ESG could be “ripe for greenwashing, and we need to be mindful,” but, she asked, “what is greenwashing in the space right now?” With little guidance from SEC about that (though this is potentially forthcoming under new proposed regulations), DeNamur says, we would do well to put our heads down and start prioritizing the environmental and social values we want our companies to operationalize. “The world is on fire. Let’s do something.” (The European Union, with its Taxonomy on Sustainable Activities, is further ahead on the greenwashing front.)

“I do think it’s important that we don’t just stand by and let this criticism take over,” agreed Cynthia Curtis, corporate sustainability officer for the Americas at JLL. “Greenwashing is not a fallacy; greenwashing happens,” she told me, but the onslaught of criticism “is in very many ways erroneous,” she added. “There are inherent risks in a changing climate,” so separating environmental and social goals from financial ones might represent a false choice. “The reality is that there is tremendous value and opportunity in understanding and appreciating that risk.”

From disclosure to action

Still, we can’t let ESG be a free-for-all, or it will be meaningless. Right now, much of what is happening is because of incentives to disclose—in much the same way that LEED v4 began encouraging material transparency—without much accountability for performance, Mandyck argued.

“Transparency is important, but we have to make sure that there are actually reduction actions,” Mandyck thinks. “You can’t make any decisions in a black box. … Now that everybody is disclosing, we need to make sure disclosures are leading to the ESG progress that we actually need.” He added, though, that “there’s no question the tools and methodologies are not perfect today. But they’re better than they were five years ago, and five years before that they didn’t exist. It’s a trend, and it’s here to stay, and I think we need to find ways to make it more robust so that it delivers the actual results that we’re all looking for.”

“I think that the confusion and this crisis in the ESG community about what is it, and does it work, is fundamentally good for sustainability,” Pyke argued. As ESG programs and the building industry begin to interact more, he believes we could see green building scale in a way that rating systems like LEED haven’t managed to spur.

“The history of green building was about providing corporations with leadership examples, or trophies—an excellent HQ or superlative factory,” Pyke said. “One excellent HQ or one excellent factory in a company with 1,000 factories was not enough.” What’s more, “it’s not equitable if people in the call center get the crappy space. We’re going to continue to need to celebrate the excellent examples, but we also need to have something to offer every building.” And ESG, with its focus on whole companies and thus entire portfolios, could be our best hope.

What’s next?

After all this back and forth and all the research I’ve done for this month’s ESG spotlight report (and am continuing to do for our ESG guide coming out in January 2023), I have mixed feelings.

I sympathize with the idea that it’s early days, perhaps too early to distinguish greenwashing from credible ESG information without SEC stepping in, but I also absolutely agree with what Makower told me: “We need to separate the indicators of corporate goodness from the indicators of corporate risk.” Even though the two are related, they’re not the same.

The question for me is whether the building industry can have much influence in a space dominated by the Boeings and BPs and Berkshire Hathaways of the world (not to mention BlackRock, which is suddenly in hot water with the State of New York for allegedly not living up to its decarbonization commitments—which it made explicitly to address financial risk to the company).

Opportunities, old and new, for building professionals

In the end, we have project decisions to make. The role of individual building professionals is pretty far removed from the ebbing and flowing whims of Wall Street.

But ESG is not going away. Clients are already asking for help in meeting ESG goals, and this is only going to increase. In this new context, the duty of building professionals is in many ways the same as ever, with a twist:

• Explore company-wide values with clients. This becomes easier through the lens of an ESG program if one exists.
• Educate clients about the environmental and social impacts, both negative and positive, that building projects can have. Draw from ESG commitments to show the intersections between these impacts and the built environment.
• Propose and advocate for specific green building strategies that align with clients’ values and ESG priorities.

And with ESG in the mix, building professionals also have opportunities to do even more. Here are a few that come to mind:

• ESG involves buildings but isn’t about buildings: it’s about companies. Help clients understand that expressing their values through a single exemplary building project without addressing the entire building portfolio won’t get them very far on environmental or social goals and could be perceived as greenwashing.
• Identify any decarbonization targets that are part of a client’s ESG commitments, and ensure they understand the impact of both operational and embodied carbon of building portfolios on their ability to meet those commitments.
• Help connect the entire process—from early design stages through construction and occupancy—with existing social or governance targets around diversity and inclusion, employee involvement, tenant engagement, labor practices, local economies, and other issues that may appear in a client’s ESG commitments or reporting.

The intersections between ESG and the building industry are still evolving. But real building projects affecting real people are moving forward rapidly in real time as this reckoning takes place in the upper echelons of the financial world. Because of this, every architecture, engineering, and construction professional has a role. With your support, clients will be able to connect abstract environmental and social commitments with tangible building strategies that have the potential to change people’s lives for the better.

Maybe there’s something to this ESG thing after all.