Steve Varley thinks environmental, social and governance investing is at a tipping point. ESG investment is the fastest-growing asset category but it is also murky and rife with misrepresentation. As global vice chair for sustainability at accounting firm EY, Varley wants to fix the flaws before it loses credibility. EY put out a report last week pointing out that there's often a mismatch between investors' aims and what ESG scores are measuring: While investors are often trying to make a positive impact, ratings firms are mostly focused on evaluating companies' risk exposure to environmental, social and governance factors rather than their impact on society. By calling attention to the shortcomings, Varley is trying to "make sure that fad doesn't explode, because at its heart, it's really trying to do something that's worthy." This interview has been edited for length and clarity. It sounds like what you're saying in this report that ESG is rife with BS claims, but it's the best we have. And so we should improve it rather than throw it out with the bathwater? I think it's been well-applied as a risk management framework within a company. And then what's happened over time is it's been used more and more by financial companies to market their products and services. And I think that it’s quite hard for investors and financial professionals to really understand what that means. If you're an investor, and you're trying to make a difference in your contribution to reducing the climate emergency, one of the things that we've worked out from looking at the ESG composites is an average of only 15 percent of your $1 investment would make a difference to climate, if you put your money into what's called ESG. The point we're trying to make in the report is that ESG is sort of the best we have at the moment, but it does need to go through an upgrade, an evolution. There are some things it's probably not destined to be and there's some things it does rather well. There's some crossroads coming up for ESG. We overall think it's a good thing, but it could be captured and misunderstood in many areas. You talk in the report about how millennials and Gen Z want to invest in ESG products. Do you think that ESG commitments are a good way to win their trust? It seems like if they're interested in sustainability, they would also be distrusting of business. I go back to my data on only 15 percent of money applied into ESG goes towards something that's got a positive climate action. It might be that a lot of Gen Z, and even Millennials, when they put that dollar into an ESG fund, they may have an automatic assumption that dollar's all going into climate. But actually, less than one in six of those funds will have a positive impact on climate. I think if we don't get better at explaining to those investors where their money's really going, then there's an opportunity for disappointment and accusations of greenwashing and then a loss of trust for that generation in particular.
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