Environmental, Social and Governance Developments

Jim Shannon Excerpts

Monday 23rd October 2023 Commons Chamber

[Alexander Stafford (Rother Valley) (Con)]

As the founding chairman of the all-party parliamentary group on environmental, social and governance, I am delighted to have secured the first ever debate on environmental, social and governance developments in the UK in this place. I refer the House to my entry in the Register of Members’ Financial Interests and to the all-party group’s interests as well.

ESG is a set of characteristics that can be used to assess the non-financial elements of an investment or business decision. In its simplest form, ESG is a way to take into account potential risks and rewards that might not be obvious from a balance sheet. Everyone, in their own way, incorporates ESG criteria into each and every economic decision, even if unknowingly.

For instance, the property developer does not buy land next to a crumbling cliff; a family might choose not to go to a particular shop because they have heard that it treats its employees badly; or a woman might change jobs to work for a firm that is fighting the gender pay gap. ESG is simply the use of non-financial criteria in decision making—a way for investors, companies and individuals to get a bigger picture of the impact of their investments, which will help them better understand the risks and, more importantly, the rewards.

Recently, there has been much debate about ESG, as it has risen in prominence. The number of ESG assets under management has grown by more than 150% since 2015, with global ESG assets expected to exceed £41 trillion or about four times the value of all the assets held in the UK. They will also account for a third of all assets under management by 2025. This scale-up has been met with some concern about ESG perhaps having some underlying political current. This is wrong. In its true form, ESG is simply an investment strategy—one that, like all investment strategies, aspires to low risk and high return. ESG is not a political stance, a way of life or a mantra for investors, although of course in some situations it is unfortunately used wrongly to pursue certain political agendas. In others, it is seen as shorthand for ethical or impact investing. However, it is neither.

In this debate, I will be sticking to our definition of ESG as an investment strategy and hoping to make the case to Government for why we should be encouraging it, what problems we have to overcome and how best to claim the crown, and the associated benefits, as the world leaders of ESG investing.

[Jim Shannon (Strangford) (DUP)]

I commend the hon. Gentleman for securing this debate. Does he agree that if we create a science-based and world-beating taxonomy, businesses that can show alignment with the UK green taxonomy will automatically be in alignment with international taxonomies, which should ensure that there is no divergence, which should subsequently enhance our capacity? Does he further agree that Government and the Minister have a role to play in assisting businesses to achieve that potential, so that all of us in the United Kingdom of Great Britain and Northern Ireland can gain and everybody can be a winner?

[Alexander Stafford]

I thank the hon. Member for intervening; it is always a pleasure when he joins such debates. He mentioned the Minister, who I know has a good, keen, personal interest in ESG, having worked in the field prior to coming to this place. The hon. Member is completely right about the green taxonomy. We need a robust taxonomy—I will come to that later—but it is a shame that we are behind where we should be with the green taxonomy. We need to be careful to ensure that our green taxonomy is robust and world leading. One of the many benefits of leaving the European Union is that we can define what we want and how we want it ourselves. By having a UK green taxonomy, we can ensure that we are world leaders in the UK, including in Northern Ireland especially, which I know has a high level of financial services.

Let me go back to the meat of my speech. It is not the case that those investing along ESG lines do not want to see good done for planet and people—they do. For example, we know that ESG investors are sometimes willing to pay higher fees and to see lower returns than their more returns-focused peers. The Wall Street Journal reported earlier this year that ESG funds could charge up to three times more. I do not exclude those types of companies and investors from this discussion. Rather, in holding the first ever debate on ESG in the House, I hope that more discourse will lead to more action.

It is clear that using non-financial metrics, and thereby factoring in all the data available to make the most rational, informed investment decision possible, will lead to financial returns. For example, more ESG-aligned employers will be able to hire better candidates for less—something known as taking a green cut, which is the attitude that up to 48% of younger people were recently reported as taking. Equally, improving environmental ratings through technology can lead to huge efficiency savings for companies. For example, some studies have shown that using low-energy lighting has a payback of less than 12 months, which is a win for the company’s bottom line and its sustainability standards. This reflexive impact of ESG is known as “double materiality”, which is how a business is affected by changing conditions—be they climate, social, or governance—and what that company is doing to contribute to or militate against those changes. That is becoming more and more important for investors to factor in.

There are also huge financial benefits to be gained from embracing ESG for the whole country, including Northern Ireland. The UK is already home to the oldest and most trusted conventional financial centre. That is coupled with the City of London’s commitment to sustainability, topping the Global Green Finance Index. Therefore, with a little extra effect, we will secure a home for ESG investors inside our border.

ESG’s recent rise in popularity has caused some growing pains. Primarily, the lack of universal frameworks and metrics mean that trust in ESG is at an all-time low, as we have seen in anti-ESG proposals approved by boards globally. In ESG investing, as in all business, trust is paramount. Just as an investor must be sure that their investment is sound, and that they will not suddenly find themselves out of pocket, an ESG investor needs to be sure that any claims to sustainability are true.

We have a rich history of accounting for financial accuracy in this country, with the Domesday Book perhaps being the earliest example—in that case, the new, or relatively new, King William checking that his investment was as profitable as he had thought. That invasion of 1066 did not come cheap. It took 800 years, and a parliamentary Select Committee to develop something closer to modern accountancy practices, but the UK is now an oasis of bookkeeping and verifiable investing. Fraudulent financial claims can be easily spotted and shut down. Why then, is the same not the case for fraudulent ESG claims?

One of the main causes of the problem is that much of what ESG seeks to account for is intangible and therefore incalculable with our current frameworks. How, for example, might a company begin to calculate its effect on biodiversity? What metric can an investor look for to see an investment’s diversity score? This problem is not insurmountable. Twenty years ago, as major economies were waking up to the true effects of increasing carbon emissions and climate change, the issue of how to count carbon seemed similarly difficult. Today, after much trial and error and leadership from the UK, we can quickly and easily calculate the carbon footprint of any business, person, or product.

Developing frameworks to help business understand, quantify and account for non-financial factors is difficult but very important. Proper frameworks are the first lines of defence against a full breakdown in trust in ESG reporting and investing. They will also help to stop so-called greenwashing, where a product or investment is marketed as being more sustainable than it is. Despite the name, this applies across all three ESG objectives. Such distrust is made worse by some ESG advisers and ratings agencies, whose business plans seem to depend on being able to sell five-star ESG ratings to the highest bidder, without giving any proof of them whatever—a veritable wild west of the ESG world. Of course, many of these businesses are doing comprehensive evaluations of the products, but given the difficulty that an investor would have in distinguishing the good ratings from the bad, it is hardly the confidence-inspiring boost that they need.

I know that the Treasury is well aware of the concerns, and I am pleased that there was a consultation held earlier this year on how best to introduce regulation on ESG ratings. This is a good and necessary step, but we are in danger of winning the battle but losing the war if we delay any further. I urge the Minister to speed up this regulation as much as possible.

We can go further than regulation, however, and set up the frameworks we need to allow any investor or company to understand quickly and easily the ESG impacts of their investments. A taxonomy—essentially a classification of what is and what is not allowed—would do just that, and the Treasury’s plan to develop a UK green taxonomy is exactly the right step. This taxonomy, as well as its social and governance cousins, would clearly outline investments that are sustainable—and therefore could be marketed as such—and those that are not. Given that the EU’s version of a green taxonomy is dead in the water—it is a bureaucratic nightmare that is no longer fit for purpose—we can make our own decisions here.

We are lucky that, thanks to Brexit, we have been given the chance to design our own robust taxonomy, one that could and should lead the world and entrench the UK as the true home of sustainable finance. Sadly, we have seen our taxonomy delayed and delayed and delayed. I was pleased to see the UK green taxonomy mentioned in this year’s green finance strategy update, but on the original timeline we should already be halfway through the legislative process by now.