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There is a way to help us all be ethical consumers – we’re just not using it yet

Many investors are already investigating whether companies are well-behaved before they put their money in. The same data they look to could be used to help consumers make the right choices

Olesya Dmitracova
Monday 14 October 2019 17:15 BST
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Nearly 90 per cent of US consumers said they would consider switching to more ethical brands if price and quality were equal
Nearly 90 per cent of US consumers said they would consider switching to more ethical brands if price and quality were equal

More and more investors are trying to invest “responsibly”, taking account of issues as diverse as companies’ carbon footprint, working conditions, executive pay and transparency on tax, to name but a few. These criteria can be gathered into three broad categories: environmental, social and governance (ESG). Taken together, they provide a metric for how “well behaved” a company is across all sorts of pressing issues.

And well-behaved companies aren’t just attractive to investors with a social conscience; there are growing indications that such businesses are also more successful, especially over the longer term. Hence another name for the trend: sustainable investing.

A landmark 2015 research paper by Deutsche Asset & Wealth Management looked at all the 2,000-plus academic studies published on the subject since 1970 and found that a large majority showed a positive correlation between companies’ ESG credentials and their financial performance, including profitability and share price. Only 10 per cent of the studies showed a negative correlation.

Among the three ESG components, good corporate governance had the greatest positive impact. “This makes perfect sense when you consider the reputational and financial damage that many companies have suffered due to a lack of oversight on governance issues. Volkswagen is a recent, stark example,” writes Fiona Reynolds, the head of a UN body promoting responsible investing.

Research published by the London School of Economics earlier this year revealed substantial firepower in the social component as well. A survey of nearly 340 studies across 73 countries found a strong positive correlation between employees’ wellbeing, their productivity, and company profitability.

And an IMF analysis published last week found that while there’s no consistent evidence that the stocks of responsible companies regularly overperform the shares of conventional firms, there’s also no evidence to suggest that they underperform. So if you can get just as good returns as you would from purely returns-driven investing, why not do something good as well?

Whatever the reason, ESG criteria are getting more popular in finance. More and more big investors are pulling their money out of fossil fuel producers, and major banks have pledged to reduce lending to the sector.

This is all good news. But I think we can do better.

Companies can be nudged into good behaviour not just by the people who invest in their stock or finance their ventures, but also by the people who buy their products. So let me propose an ESG certification aimed at consumers.

Imagine if products could be labelled using a traffic light system, based on common ESG scores, to indicate the ethical credentials of the company that makes them. For services, the label could appear on a firm’s website and promotional materials.

Companies labelled green could charge a premium, or they could instead rely on expected greater demand for their offerings and reap the benefits of their exemplary conduct in the form of higher revenues.

There is evidence that the second approach would work. In a 2017 survey in the US, 89 per cent of consumers said they would consider switching brands to one associated with a good cause if price and quality were equal. In the UK, inflows into ethical funds have held up remarkably well this year, while other funds have suffered withdrawals.

I realise that setting up an “ethical” certification like this wouldn’t be easy. For one thing, ratings are very expensive to produce, with some providers charging tens of thousands of dollars per year. For another, there are currently no standardised criteria for ESG scores; a number of different firms come up with ratings, and these can differ between providers. And while the European Commission is working on ways to standardise ESG scores, this is a relatively new and highly complex field, meaning these ratings are much more inconsistent than other more established ones issued by credit agencies.

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But as far as many investors are concerned, what’s more useful is not a company’s overall ESG score but the underlying data, which they can analyse themselves as they decide whether investing in that company would match their values.

Hopefully, in the not-too-distant future, ESG-rating firms could be incentivised to sell their headline scores cheaply or even give them away for free. That way they could be printed on consumer products, while the bulk of the firms’ profits will come from selling the more granular data to professional investors.

And as an added bonus, widespread ESG labelling could also help change public perceptions of the financial industry. Yes, the sector has given the world mortgage-backed securities and collateralised debt obligations. But if it can also devise a way to nudge companies into ethical behaviour, then surely it’s not all bad.

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