Home Business Insights & Advice Proposed ESG labels speak to broader concerns about over-labelled society

Proposed ESG labels speak to broader concerns about over-labelled society

by Sarah Dunsby
27th Oct 23 2:13 pm

Over a decade ago, the Deepwater Horizon disaster dumped over 200 million gallons of crude oil into the Gulf of Mexico, killing 11 people instantly and countless more indirectly—and wreaking havoc on one of the Earth’s most biodiverse marine habitats. If there was a upside to the catastrophe, however, it was that the accident thrust ESG (Environmental, Social, Governance) concerns into the limelight.

The financial sector underwent a significant transformation after Deepwater Horizon, as global awareness of ESG risks was heightened. ESG ratings have since become pivotal in guiding investments, with investors keen to position themselves as eco-friendly by acquiring assets that have earned the coveted label “sustainable”—indeed, some $2.8 trillion in funds are now marketed as sustainable according to Morningstar.

However, as ESG has become a corporate buzzword, ESG labels have attracted increasing scrutiny. Regulators and policymakers across the globe are now delving deeper, demanding greater transparency surrounding these kinds of ratings. In late September, the US Securities and Exchange Commission (SEC) implemented new transparency requirements, including a rule requiring that 80% of a fund’s portfolio match the asset implied in its name—a move intended to crack down on rampant greenwashing, or efforts to market funds as “sustainable” in cases where this label is in fact deceptive. The EU, meanwhile, is set to debate a proposed law later this year that would force ESG rating agencies to demonstrate increased independence and disclose additional information concerning their methodology.

The increased scrutiny is long-overdue: while surveys show that a significant majority of investors consider ESG in their portfolios now, studies have laid bare a “Wild West” of sustainability claims in which many labels “mean very little” or are outright misleading.

Indeed, this parallels a broader trend across countless industries, from food to fashion, where an ever-increasing number of labels are popping up, purporting consumers to help make more informed choices—yet which may in fact be confusing them or intentionally leading them astray. While certain corporations stand to gain immensely from these opaque ratings, it’s often the unsuspecting end consumer who is left in the lurch.

After SEC, EU next to address ESG label opacity

The impetus of the proposed EU law regarding ESG transparency stems from the fact that the European Commission has identified several areas of potential conflict of interest at the heart of ESG ratings agencies, including selling ratings, data, and indices to the same investor clients; offering consultancy services to help companies boost their ratings.

Daniel Cash, a Hong Kong-based credit analyst, compared the current ESG landscape to how credit rating agencies operated before the 2008 financial crash: “they were using consultancy services as cash cows and essentially the rating agencies are doing the same thing.”

Even though ESG rating agencies insist that they have undertaken several important reforms, including introducing informal firewalls to separate analysts from those in client-facing positions, the EU is right to seek still further transparency, as major issues remain.

For one thing, many ESG ratings actually measure how well a company is managing ESG-related risks to its own bottom line, rather than measuring their performance on metrics like carbon emissions–which is how many people would naturally interpret the label. A similar kind of confusion lies at the heart of one of ESG ratings agencies’ best-selling products—temperature scores, which purport to assess which planetary warming trajectory a company’s actions align with. Looking at the fine print, however, reveals that most ESG ratings evaluate based on companies’ management of risks relative to their peers—not on their impact on the planet.

Similar concerns across a range of industries

As one professor noted, this sets consumers up for disappointment—”there is disillusion and confusion when people realise the labels mean very little or do not measure what they want them to measure”.

This predicament isn’t unique to ESG ratings. There is increasing debate, for example, over whether some widespread front-of-pack (FOP) nutritional labels actually measure what they purport to—and whether they provide helpful information for consumers. Much of the debate in Europe has centred around the French system Nutri-Score, once expected to be the frontrunner for a harmonized label across the European union. While labels like Nutri-Score—which ranks foods from a green A, supposedly healthiest, to a red E, supposedly the least healthy, were ostensibly conceptualized to guide consumers towards healthier dietary choices, the label’s questionable algorithm appears not to be rooted in scientific reality. The Romanian National Authority for Consumer Protection (ANPC) has already outlawed the use of the Nutri-Score label.

The fashion industry has also seen its share of labels pinned as misleading. Over the past few years, clothing has been slapped with labels such as “eco-friendly”, “sustainable” or “organic”. These labels appeal to increasingly eco-conscious consumers—yet in many cases, are simple greenwashing or “clearwashing”—when a brand gives the appearance of transparency and seems at first glance to be providing consumers with a wealth of information, only for that information to turn out not to be that meaningful. For instance, while “vegan leather” might sound environmentally friendly, it’s often just a rebranded version of “pleather” or plastic leather, which is not sustainable. As there is no agreed-upon definition for these labels, brands are able to define sustainability based on their own interpretations that allow them to justify growth and profit rather than positive impacts on the planet.

The need for genuine transparency in labelling

The proliferation of ESG labels and their counterparts in various industries underscores a pressing concern: the potential for misleading or deceptive labeling practices that can confuse or mislead consumers. As the world becomes more conscious of environmental, social, and governance issues, the demand for genuine transparency in labelling has never been higher. Whether it’s in the financial sector, the food industry, or the fashion world, consumers deserve clear, accurate, and meaningful information to make informed decisions. Regulatory bodies like the SEC and the EU are taking steps to ensure that labels truly reflect the values they purport to represent. However, it’s crucial for industries and companies to self-regulate and prioritize genuine transparency over marketing gimmicks. Only then can consumers trust that the choices they make align with their values and the broader goal of a sustainable future.

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