[Opinion] The Path Forward and Overcoming Limitations of ESG Management and Investment

Since the outbreak of the novel coronavirus disease (COVID-19), global interest in ESG (Environmental, Social, and Governance) management and investment has surged. In the second quarter alone, $71.1 billion flowed into ESG funds, pushing the total global ESG fund size to an unprecedented $1 trillion. This appears to be because investors increased ESG investments as a risk management measure after confirming that companies with strong ESG performance demonstrated higher crisis resilience during COVID-19. In South Korea as well, 98.2 billion KRW has flowed into ESG-related public funds since the beginning of the year, marking a 25% growth rate, and the returns have outperformed equity funds.

With the government implementing the Korean version of the Green New Deal policy, the number of ESG-related financial products is expected to increase. As the policy focuses on eco-friendliness, asset management companies are launching or preparing not only equity but also bond-type products, which are likely to concentrate investments in electric vehicles, secondary batteries, alternative energy, healthcare, and more. Corporate interest in ESG management is also rising. The Korea Corporate Governance Service annually evaluates the ESG levels of domestic listed companies and publishes ratings. According to this year’s evaluation results, the number of companies rated as excellent or good increased across all areas of environment, society, and governance, reflecting heightened ESG awareness among companies listed on the Korea Exchange compared to the previous year.

Although ESG management and investment are spreading, challenges and limitations remain. First, standardized reporting criteria for ESG management and investment have yet to be established. To achieve the goals of ESG management and investment, companies must accurately convey ESG performance information so that investors can make informed investment decisions and stakeholders can efficiently make decisions related to the companies. While some ESG-related reporting standards exist globally or by industry, most are developed by the private sector and lack consistency and universality. This contrasts with the reality where financial information is globally standardized and delivered through reporting standards and formats such as the International Financial Reporting Standards (IFRS). Fortunately, on the 30th of last month, the IFRS Foundation released a consultation document on sustainability reporting, marking a meaningful first step toward unifying standards for reporting non-financial information, including ESG.

ESG management is not merely corporate social contribution activities. It involves discovering and implementing company-specific management strategies and business models that enhance corporate value in the mid-to-long term while contributing to social development and environmental improvement. The fundamental difficulty companies face in ESG management is skepticism about whether ESG efforts will be properly evaluated in the market. Since ESG management inherently aims for mid-to-long-term results, if companies’ ESG efforts are not adequately assessed, all their efforts will amount to mere cost waste, and they will lose motivation to pursue ESG management in the future.

To prevent this vicious cycle and establish ESG management, ESG investment must be activated above all else. ESG management and investment are two sides of the same coin: improvements in corporate management performance through ESG management should lead to higher returns on stocks and bonds issued by those companies, enhancing ESG investment performance. Consequently, funding for these companies becomes smoother, capital costs decrease, and ESG management expands, creating a virtuous cycle. While advanced countries have begun to establish this virtuous cycle with active ESG investments centered on public pension funds, the reality is that South Korea has yet to achieve this. To overcome this stagnation, active ESG investment by large public pension funds such as the National Pension Service appears necessary.

ESG management is no longer optional but essential. For ESG management to be properly implemented, corporate governance?the foundation of corporate decision-making systems and operations?must be improved. If a company advocates social development and environmental improvement while simultaneously infringing on the interests of minority shareholders through the arbitrary actions of controlling shareholders, private benefit extraction, or preferential treatment of related parties, ESG management will be meaningless.

Jinyoung Shin, President of Korea Corporate Governance Service and Professor at Yonsei University School of Business