ESG assessments of companies’ sustainability risks do not have the qualities needed to qualify as a measurement of the economy’s green transition to increased sustainability. Neither do ESG assessments represent enough of a driving force for most companies, in spite of sustainability being seen as key to competitiveness.

ESG as a measurement of and driving force for a green transition

Interest in sustainability issues has increased greatly in the financial sector. Within the industry, sustainability is operationalised through so-called ESG assessments of companies’ Environmental (E), Social (S) and Governance (G) risks and opportunities. The assessments are based on a number of indicators under each topic that are weighed together into a combined assessment. A great deal of policy work is under way, including at EU level, for the purpose of creating incentives for and influencing capital and investments so that they support sustainable development, partly on the basis of these ESG assessments. However, to be successful this work assumes a good knowledge of the measurements that are used and the driving forces for those subject to regulation.

In this memorandum, we have analysed whether ESG assessments have qualities that enable them to be used as a measurement of a company’s environmental sustainability and, when aggregated, as a measurement of the sustainability of the economy. Our second purpose has been to analyse whether ESG assessments represent a driving force for companies’ sustainability. The analyses are based on literature studies and interviews with financial market actors, ESG assessors and assessed companies.

Sustainability has become a strategically significant issue

Sustainability has gone from being an issue of values to being an issue of strategic and financial importance to company management. For asset managers and institutional investors, sustainability issues have begun to be much more integrated into the investment process in the form of various analyses of sustainability risks and,–increasingly, opportunities. ESG assessments now represent a tool in the assessment of risks and opportunities. The market for assessments has grown and also consolidated. Demand for a high level of coverage has led to more companies being assessed and to methods becoming standardised.

ESG assessments contribute knowledge but require qualified interpretation

However, ESG assessments do not have the qualities needed to qualify as a measurement of companies’ and the economy’s sustainability risks and opportunities. Different ESG suppliers weight the underlying indicators of ESG assessments differently, which results in very significant variations in the overall assessments. Users of the assessments are aware of this and do not use them without further analysis of their own.

The validity – that is to say the extent to which the right thing is being measured – is unclear. The intention of ESG is to capture different types of sustainability risks, such as policy, market and reputation risks. These are captured with the aid of a wide range of different categories of indicators, such as policies, actions, results, controversies and the extent to which the company’s products address society’s sustainability problems. However, there is a risk that ESG assessments largely reflect how well companies report their sustainability work, rather than how sustainable their operations are.

The reliability of ESG assessments is also lacking in a number of ways. ESG suppliers assess companies’ ESG performance by industry sector, the reason for which is that what is material for profitability and sustainability differs from industry to industry. This leads to ESG assessments being at best a relative indicator of how a company ranks in terms of sustainability within an industry. It is therefore not possible to compare ESG assessments between industries. And because ESG methods are being constantly developed, neither is it possible to use the assessments to reliably follow developments over the course of time.

ESG assessments only represent a driving force for a few companies

Our interviews with companies show that sustainability, as with the assessors, is being increasingly seen as a central issue for company competitiveness. Sustainability risks are generally perceived by these companies not as risks but as opportunities. The companies that were interviewed were not worried by either new regulations or changes in demand. On the contrary, many of them think that sustainability requirements from politicians and customers are important driving forces and that they are positive for their competitiveness.

The companies do not have a consistent definition of sustainability. Instead, they decide based on their respective business areas what sustainability aspects they judge to be most important and they have their own definitions and objectives. Many are aware of ESG, but only a few have the intention of maintaining a high ESG rating or of raising it. However, many of the companies are positive about being assessed and do not see the assessment process as burdensome, but rather as a learning process.

Policy implications

There are many reasons why it is important for ministries and authorities to have good knowledge about ESG measurements, their development and their implications for the economy. Firstly, because these are the measurements that the financial market uses to integrate sustainability into their investment decisions, which in turn can have great significance for how sustainably financial resources are allocated. Secondly, ESG assessments can affect companies in a sustainable direction, through their access to and cost of external capital.

However, at present there is not sufficient knowledge about the assessments’ validity and reliability. Research into this area indicates that there is no contradiction between ESG performance and financial performance, but there are no studies of the extent to which ESG correlates with key measurements of sustainability or of the causality between ESG assessments and environmental sustainability.

At present, ESG assessments can only be used as a basis for analysis of the economy’s sustainability with significant caution. Using them requires in-depth knowledge of the specific version of ESG assessment used, and even then the assessment needs to be supplemented with further data and analysis. The main value of ESG assessments is that they contribute to increasing knowledge about sustainability in both the financial sector and the assessed companies.

The significance of ESG measurements in the future will depend on what consumers and politics demands of companies as well as how climate and environmental risks develop. In other words, government initiatives that make sustainability more profitable have potential, through ESG assessments, to influence how capital is allocated. More research is needed, however, to investigate exactly what financial effects can be expected and how government initiatives should be designed to achieve the desired effect.