Environmental, social, and governance (ESG) ratings are scores that investors use to judge a company’s stance and strategy for ESG concerns.
Typically, a quantitative metric, the ratings are provided by both established credit ratings agencies and specific ESG rating agencies. In June 2023, the European Commission announced plans to amplify the regulation of ESG ratings, ensuring rating agencies are independent and their methodologies are rigorous.
GlobalData predicts that increased mandatory climate reporting will lead to more accurate and verifiable scores in 2024 and beyond. Management teams have begun paying close attention to ESG ratings while they strive toward sustainable investing and business practices. These ratings will be the key to environmental action that is fundamentally capitalist in nature.
Given large corporations are some of the worst offenders for emitting greenhouse gases, businesses must play their part in climate mitigation. Sustainable investing has become crucial to the fight against climate change because it is one of the very few climate measures that are not all but ruled out by our collective choice of economic system: capitalism. Capitalist society rests on the idea that any individual can do what they like with their privately owned property.
Large-scale government interventions cannot be capitalist
There are many reasons, both ideological and practical, why capitalism makes it hard to effectively battle climate change. Firstly, capitalist theory is unwavering in its focus on self-interested, individual consumers. If this is the case, then the major polluters of the world (CEOs of big companies) have no incentive to reduce emissions because they are unlikely to be affected by climate change. On top of this, the ideology of the free market holds that levels of production should be solely determined by businesses and consumers and that more consumption is always better. If governments abide by this, they will be unable to regulate production and consumption in any way.
Finally, the foundational premise of private property means that capitalist governments have very little control over how the capital in their country is invested. If it is most profitable to invest in carbon-guzzling projects, then capital owners are free to do so.
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While, of course, no country on the planet is 100% capitalist—and almost all could be described as mixed economies—these ideas are on the minds of every policymaker in the world. Many governments do regulate production and attempt to sway investment, and many individuals are frequently motivated by altruism more than ego. However, it is true that the large-scale government interventions that activists campaign for are not truly capitalist.
ESG ratings offer a solution to our climate catch-22
Sustainable investing based on ESG ratings is a form of climate action that avoids these problems. The main reason for this is that ESG ratings provide a market-based incentive for companies to improve their ESG credentials. At present, legislation and pressure from the government is the most common answer given to the question of why a company should set up an ESG performance plan, according to GlobalData polls. As ESG ratings become more regulated, standardized, and prevalent, investor pressure may become a more prominent motivating factor.
On top of this, ESG ratings are determined both by a company’s impact on ESG concerns and by the way that its ESG actions will affect its bottom line. This means investors will not have to move away from profit-seeking behaviour to improve their climate credentials. The growing prevalence of ESG ratings will also allow investors to put their money where they want without government intervention—they will just have the information to know the impact of their investments.
While living in mixed economies means our efforts toward climate mitigation do not need to be completely capitalist, it will surely help to combat the growing anti-ESG movement to have this capitalist tool in our climate action belt. And coherence in our approach and way of life is surely good for our peace of mind.