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June 8, 2023

What is ESG 2.0?

There have been two distinct periods of ESG or environmental social governance ESG 1.0 and ESG 2.0. ESG 1.0 is the period between 2004 and 2018, when the concept of ESG began to be a factor in lending and investing decisions, it began with the conceptualization of ESG as a framework, and ends with new European Union disclosure requirements for larger companies. 

A 2004 United Nations report alerted capital markets to ESG. By linking these factors to company value, and as a means of reducing risk in the mid to long term. Lenders and investors began factoring ESG into their lending and investments to companies with the expectation of reducing their exposure to environmental and social risks. 

Companies voluntarily reported their ESG performance using a profusion of new ESG standards, principles, guidelines, frameworks, ratings and scores. A growing and unregulated ESG data industry emerged, estimated to be worth $1 billion in 2022. Arguably ESG disclosures often amounted to little more than public relations or marketing. Companies can deliberately mislead stakeholders by selective use of information to appear more positive than they are. Such practices as greenwashing, blue washing, and harsh washing became commonplace. 

In practice, the effectiveness of ESG 1.0 amounted to little more than a marketing tool. It was based on disclosure by companies and investors that was unregulated, voluntary, self assessed, and cherry picked to signal ESG credentials to the market without any substantive change in performance. 

ESG 2.0 is being driven by regulators who are responding to the perceived threat that climate change poses to the stability of the financial system. These regulators are working in a coordinated and networked ecosystem in over 40 jurisdictions worldwide. Their stated aim is to standardise definitions and metrics and to counter greenwashing in financial markets and in the corporate sector. 

In financial markets, the main thrust of regulation is mandatory product labelling, that is the labelling and monitoring of investment vehicles, according to their stated ESG or sustainability impacts. In the corporate sector, companies must comply with new disclosure requirements and measure ESG or non-financial impacts in a way that is material for investors and comparable with financial reporting standards. The aim is to lower risk for investors and lenders. 

Finally, ESG 2.0 is also characterised by market incentives. Legislators and banks in most major economies are increasingly making green finance available for sustainable projects to give progressive companies easier access to capital on preferential terms. The aim is to leverage capital markets to effect to just transition to net zero. ESG 2.0 regulates ESG disclosure, makes it a mandatory activity and underpins it with a new global baseline of sustainability accounting standards. 

In summary, ESG 2.0 is fundamentally different to the period of ESG 1.0. It shifts ESG disclosure from being unregulated, to regulated from being voluntary to being mandatory from being self assessed and cherry picked to being based on accounting and assured data that aims to be consistent and comparable with financial data.

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