The Crisis of Environmental, Social, and Governance (ESG) Standards: An Opportunity to Voluntarily Embrace Positive Business Impact

This article, written by José Ignacio Morejón, a partner in Ecuador, explores the crisis of ESG standards in the United States and hyperregulation in the European Union, presenting the opportunity to evolve towards a voluntary approach focused on positive business impact.

The Crisis of Environmental, Social, and Governance (ESG) Standards: An Opportunity to Voluntarily Embrace Positive Business Impact

In the realm of corporate sustainability, ESG standards have been a topic of significant debate in recent years. While the United States has been grappling with a crisis of acceptance and implementation of these standards, the European Union has opted for intensive regulation, which many consider excessive. This paradox between distrust in the United States and hyper-regulation in the European Union has created a complex landscape for companies and investors. However, this situation could present an opportunity to evolve ESG standards towards sustainability focused on positive impacts linked to business models voluntarily.

BlackRock, one of the world’s largest investment funds, initially embraced the ESG wave with great enthusiasm. Its CEO, Larry Fink, repeatedly emphasized the importance of sustainability and social responsibility in investments. However, recently, BlackRock has made a notable shift, stepping back from its role as an ESG ambassador by omitting these principles from its annual letter.

BlackRock’s decision to distance itself from ESG fervor stems from several factors:

1. Political Pressure: In the United States, certain political sectors have strongly criticized companies that prioritize ESG standards, arguing that it is more of a political agenda than a legitimate business strategy.

2. +Financial Results: Post-COVID economic volatility, inflation, and recession have led investors to seek greater security and lower risks, reducing the appetite for investments that prioritize sustainability over immediate financial returns.

Fink has emphasized that while sustainability is important, it should not be imposed in a way that compromises financial returns and economic stability.

The European Union has implemented a series of strict regulations to ensure that companies comply with ESG standards. Among the most notable is the new sustainability reporting regulation, known as the Corporate Sustainability Reporting Directive (CSRD). This regulation obliges companies to provide detailed information on their environmental, social, and governance impacts, significantly expanding the scope and depth of sustainability reports.

While the CSRD has led to greater transparency and accountability, it has also drawn criticism for being perceived as excessive and impractical for many companies, particularly small and medium-sized enterprises (SMEs). In an economic recession context, the bureaucratic burden imposed by this regulation can be especially onerous. SMEs, which often operate with limited resources, may find it challenging to meet the exhaustive reporting requirements without diverting a significant amount of time and resources from their core operations.

This situation could lead to a backlash, where companies feel overwhelmed and disincentivized to adopt sustainable practices, precisely at a time when resilience and operational efficiency are crucial for surviving the economic downturn. While the intention of the CSRD is commendable, its implementation needs to be sensitive to the capabilities and needs of SMEs to avoid the regulation becoming a barrier rather than a catalyst for sustainability. In summary, it is crucial to find a balance that promotes transparency and social and environmental stability without stifling the dynamism and innovation of small and medium-sized enterprises.

The COVID-19 pandemic left a significant mark on the global economy. Inflation, recession, and high interest rates have created an environment of low risk tolerance. In this context, ESG investments have been viewed as a luxury that many cannot afford. This has led to a reevaluation of investment strategies, where security and short-term profitability have gained priority over ESG investment.

The economic recession and high inflation have negatively impacted the appetite for ESG-focused investments. However, this scenario has also highlighted the importance of investments that generate a materially positive impact, beyond mere compliance with ESG standards, as a strategy for mitigating social and environmental risks.

Social movements in recent years in Latin America have demonstrated the economic and social vulnerability in various countries in the region, as well as the interrelation between social well-being (or discontent) and the continuity of private productive activities. For example, in 2019, Ecuador experienced protests that paralyzed the economy, generating significant losses. In 2022, Colombia, Chile, Bolivia, and Brazil faced similar situations, with significant economic costs:

What role does the private sector play in safeguarding this balance? The close and delicate relationship between social, environmental, and economic well-being motivates us to recognize the interdependence among the various market actors, especially in Latin America, and the necessary care and monitoring required for this management to ensure a license to operate and business sustainability.

The current inability of Latin American states to face these challenges alone highlights the importance of the private sector. Companies can seize this crisis as an opportunity, capitalizing on good management of positive impacts. This will not only allow them to generate trust and credibility but also position themselves as allies of development, beneficial to both people and the planet.

In contrast to hyper-regulation, voluntarism in incorporating sustainability into business is gaining ground. This approach allows companies to adapt their sustainability strategies to their specific contexts, creating a strategic niche for positive material impact.

Positive material impact refers to business actions that generate tangible and lasting benefits for society and the environment. Unlike the traditional ESG approach, which often focuses on avoiding harm, positive impact actively seeks to create value and a license to operate. This positive impact approach is being put into practice in the Triple Impact Alliance led by AMCHAM Ecuador, where more than a hundred organizations and companies in the country have committed to using commerce as a force for good. To this end, they are shifting from the ESG approach to increasing positive impact: all measure their positive impacts, manage them under the same international standards, and improve their prioritized social indicators, both individually and collectively. The objective of this initiative by 2027 is to contribute from the private sector to the social regeneration of the country through concerted plans, based on impact data, that reduce poverty and boost employment from a holistic perspective, taking into account their impact on the families and communities of their employees. The publication of the First Positive Business Impact Index is expected by 2025.

The measurement and management of positive material impacts are key elements in the corporate strategy to achieve a license to operate, reduce risks, and improve performance in the short, medium, and long term. This is especially relevant in Latin America, a region characterized by social instability, unfavorable economic projections, and a lack of investment in social issues. Proper management of positive impacts can strengthen companies' trust and credentials, positioning them as key allies in the region's sustainable development. For this purpose, there are free tools such as the B Impact Assessment. More than 150,000 companies worldwide use this tool to measure, manage, and improve their positive performance in areas such as the environment, community, customers, suppliers, employees, and shareholders.

The B Corporation movement has positioned itself as a viable response to the challenges posed by traditional ESG standards. Certified B Corporations are those that meet the highest standards of social and environmental performance, public transparency, and legal accountability, achieving a balance between purpose and profit. At iitos, we believe in this approach, which is why we have maintained our status as a Certified B Corporation since our founding.

Conclusion: An Opportunity to Evolve Sustainability

The crisis of ESG standards in the United States, marked by growing resistance and distrust, and hyper-regulation in the European Union, which has overburdened many companies, have created a complex environment for companies and investors. However, within this challenge lies a unique opportunity: the transition from traditional ESG standards to positive impact standards.

Unlike conventional ESG standards, which often focus on mitigating negative impacts and complying with regulations, "positive impact standards" go beyond. These standards actively seek to generate tangible and lasting benefits for society and the environment. It’s not just about avoiding harm, but about creating real and additional value for all stakeholders: employees, customers, communities, and the environment, without compromising business profitability.

Certified B Corporations are an excellent example of how these standards can be successfully implemented. These companies not only meet high standards of sustainability and social responsibility but also measure and certify their positive impact in key areas such as governance, community impact, environmental sustainability, and fair treatment of employees. Unlike ESG standards that may focus on avoiding risks, positive impact standards seek opportunities to create meaningful and measurable change. This includes everything from implementing fair labor practices to proactively reducing carbon footprints, to supporting local communities through social development programs.

This approach, in addition to being more pragmatic and adaptable to business realities, offers a viable path to effectively and profitably integrate sustainability, using business as a force for good. The B Corp movement, which brings together companies committed to these standards, demonstrates that it is possible to run businesses with a focus on positive impact, creating sustainable value for all stakeholders and promoting a more just and equitable future.

Companies like Patagonia and Natura Co. have shown that by adopting these positive impact standards, they have not only overcome economic and social challenges but have also thrived and positioned themselves as leaders in their respective sectors. These companies do not just survive in difficult times; they thrive by turning challenges into opportunities, underscoring the resilience and competitiveness that a positive impact-focused approach offers.

In summary, the key for companies in the current context lies in adopting a holistic and voluntary vision of sustainability, centered on generating lasting benefits for society and the environment. This path will not only contribute to a more just and equitable world but will also strengthen the resilience and competitiveness of companies in the long term, preparing them to lead in an increasingly demanding and conscious market.