This article first appeared in The Edge Malaysia Weekly on September 18, 2023 - September 24, 2023

The late Kofi Annan, who was secretary-general of the United Nations (UN), surprised the world in 1999 when he began pitching for businesses to join the UN in a “creative partnership” that would benefit both parties.

Annan made his points clear: The UN cannot achieve its goals in peacekeeping or addressing human rights without the business community, who will equally benefit when the world is peaceful and global markets are functioning properly.

Globalisation has brought prosperity, but its fragility has been underestimated. “The spread of markets outpaces the ability of societies and their political systems to adjust to them, let alone to guide the course they take. History teaches us that such an imbalance between the economic, social and political realms can never be sustained for very long,” said Annan at the World Economic Forum in Davos.

Following this, the UN began convening some of the world’s largest corporations to form the UN Global Compact and UN Principles for Responsible Investment to tackle human rights and environmental issues, among other issues.

In 2004, it published a report called Who Cares Wins, which promoted ESG as a mechanism for businesses and investors to consider environmental, social and governance factors in their operations and investments for the first time. The report was endorsed by major financial institutions like Morgan Stanley, BNP Paribas and HSBC.

The environmental angle was chosen because many reports that outline the risks of climate change and resource limitations were released in those decades. Social issues, meanwhile, are important to labour-affiliated pension funds and to the UN’s work in developing economies. Governance is already a widely considered factor by investors.

But the question many investors had was whether considering these traditionally non-­financial factors goes against their core duty, which is to maximise profits. That is why, in 2005, the UN commissioned law firm Freshfields Bruckhaus Deringer to study whether the integration of ESG issues into investment policy was against asset managers’ fiduciary duty.

The study concluded that the “links between ESG factors and financial performance are increasingly being recognised”, so “integrating ESG considerations in an investment analysis … is clearly permissible and is arguably required in all jurisdictions”. This was regarded as one of the most effective documents that promoted the integration of ESG into institutional investments.

In the next few years, the UN hosted closed-door events for investment professionals to engage with institutional asset owners and companies on ESG issues. In the years after the Who Cares Wins report was published, fewer than 1% of earning calls mentioned ESG. By 2021, nearly one-fifth of earnings calls and a survey showed that 72% of institutional investors were implementing ESG factors, according to investment firm Pimco.

Firstly, this is a major effort to include the private sector in addressing the world’s problems. Businesses have leveraged natural resources and human capital to grow. But this has also had negative impacts on the environment and society, which will in turn threaten the existence of businesses if left unaddressed.

Secondly, the UN empowered banks and institutional investors to become the first movers, since these parties dictate where funds flow and can influence companies through their shareholding.

Thirdly, the UN established that a focus on ESG issues is good for a company’s financial performance and is not something done for purely ethical reasons. The latter is what sets ESG apart from corporate social responsibility (CSR) and faith-based investing.

What is notable is that the language used around ESG is from the world of conventional finance, and this is why some believe ESG has become more popular than concepts like CSR. The development of reporting frameworks and metrics in ESG are also contributing factors.

Instead of imposing the idea that businesses have a moral responsibility to consider non-financial factors like climate change and social issues, ESG made a “business case” for it by framing it as a risk management tool that can also uncover new business opportunities.

But is asking businesses to consider and report ESG factors enough to spur actual change on the ground? Who defines what is “ESG enough”? That will be addressed in the next article.

Additional sources:

The Making and Meaning of ESG by Elizabeth Pollman (2022), University of Pennsylvania

From a Financial to an Entity Model of ESG by Iain MacNeil and Irene-marié Esser (2022), University of Glasgow

This series of articles was produced by the author when she was a Khazanah-Wolfson press fellow at the University of Cambridge from April to June 2023. The fellowship is sponsored by Khazanah Nasional Bhd.

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