Environmental, Social, and Governance (ESG) investing has taken off in recent years. More investors want their money to align with their values, but how does that work?

Not all companies or funds automatically qualify as ESG. They must meet specific environmental, social, and governance standards set by rating agencies, regulators, and fund managers. The problem is there’s no universal definition of what makes an investment truly ESG.

This article unpacks how investments earn ESG status. You'll learn what goes into ESG ratings, how funds get labelled, and why scores can differ. We’ll also cover the challenges of ESG investing, including concerns about greenwashing and evolving standards.

Whether you're a long-term investor considering ESG funds or just curious about how companies earn their sustainability credentials, this guide can help you cut through the noise.

What is ESG?

ESG – Environmental, Social, and Governance – is a framework used to assess how companies manage sustainability, social impact, and corporate behaviour. Here’s the gist of each of the components:

• Environmental factors look at issues like carbon emissions, waste management, and energy efficiency.
• Social factors cover labour rights, workplace diversity, and community impact.
• Governance factors focus on board diversity, executive pay, and business ethics.

ESG investing has grown as more people consider ethical and sustainability factors alongside financial returns. Governments and regulators have also increased ESG reporting requirements, making it a bigger focus for businesses.

Some investors see ESG as a way to support responsible businesses. Others believe strong ESG practices may help companies manage risks and adapt to long-term changes. While ESG investing is gaining traction, approaches to measuring ESG performance vary, leading to different interpretations of what qualifies as ESG.

Criteria for ESG investments

Investments earn ESG status by meeting specific environmental, social, and governance standards. Here are the pillars for ESG standards:

Environmental

The environmental pillar assesses how companies manage their impact on the planet. Key factors include:

• Carbon emissions and climate impact
• Energy use and transition to renewables
• Waste management and pollution control
• Sustainable sourcing of materials

Social

The social pillar looks at how companies treat people – employees, customers, and communities. It considers:

• Workplace safety and labour conditions
• Diversity and inclusion policies
• Community engagement and corporate social responsibility
• Ethical supply chain practices

Governance

The governance pillar focuses on how companies are run and whether they act in shareholders’ best interests. It includes:

• Board diversity and leadership accountability
• Executive pay structures and transparency
• Anti-corruption policies and ethical business practices
• Shareholder rights and corporate decision-making

Different ESG rating providers weigh these factors differently. Some focus more on climate impact, while others prioritise social policies or corporate governance. This explains why the same company can receive different ESG scores from different agencies.

How ESG ratings work

Though ESG ratings help investors assess how companies manage environmental, social, and governance risks, not all ratings follow the same system.

Major ESG rating agencies

Several agencies evaluate ESG performance, each with its own approach:

• MSCI assesses how well companies manage ESG risks compared to their peers.
• Sustainalytics focuses on a company’s exposure to ESG risks and how effectively they handle them.
• FTSE Russell ranks companies based on ESG performance across multiple categories.

How ESG ratings are determined

Agencies collect and analyse data from various sources, including:

• Company reports and sustainability disclosures
• Government databases and regulatory filings
• Media coverage and third-party research

Why ESG scores vary

A company might receive different ESG scores depending on the agency. This happens because:

• Rating providers use different criteria and scoring methods
• Companies disclose varying amounts of ESG data
• Some agencies adjust scores based on industry norms

For investors, this means an ESG score is just one piece of the puzzle when assessing ESG investments. Understanding how the rating was determined can help provide a more accurate picture.

ESG regulations and standards

There’s no single global rulebook for ESG investing. Instead, companies follow different regulations and standards depending on their location and industry. Some rules are mandatory, while others are voluntary guidelines designed to encourage transparency.

International ESG frameworks

Several global standards help define ESG reporting:

• European Union (EU) Taxonomy – A classification system that identifies which economic activities are considered environmentally sustainable.
• Sustainable Finance Disclosure Regulation (SFDR) – Requires European investment funds to disclose how they consider ESG factors.
• Global Reporting Initiative (GRI) – A widely used framework for companies to report on sustainability impacts.
• Sustainability Accounting Standards Board (SASB) – Provides industry-specific ESG reporting guidelines.

ESG regulations in Australia

Australian companies and investment funds follow various local guidelines, including:

• ASX Corporate Governance Principles – Recommends ESG disclosures for listed companies, particularly in areas like climate risk, diversity, and ethical conduct. While not legally binding, many companies follow these principles to meet investor expectations.
• Australian Prudential Regulation Authority (APRA) guidance – Encourages banks, insurers, and super funds to assess and manage climate-related risks, ensuring financial stability. APRA expects institutions to integrate ESG risks into their overall risk management strategies.
• Australian Securities and Investments Commission’s (ASIC) greenwashing rules – Ensures companies and funds don’t mislead investors about ESG claims. ASIC has increased scrutiny on misleading sustainability claims, holding businesses accountable for inaccurate ESG-related statements.

Mandatory vs voluntary ESG disclosures

Some ESG reporting is required by law. In the EU, large companies must disclose sustainability risks under the SFDR. Australia is also introducing climate-related reporting requirements for big businesses.

Many companies choose to report ESG data even when not required. This helps them attract ESG-conscious investors and meet global standards.

Since ESG reporting rules differ across markets, ESG labels and claims can mean different things depending on where an investment is based.

ESG certification and investment products

ESG labels aren’t just for companies – funds and exchange-traded funds (ETFs) can also earn ESG status. But how do they qualify, and who decides?

How funds and ETFs earn ESG labels

Investment funds must meet specific ESG criteria to be classified as ESG. This often involves:

• Negative screening – Excluding industries like tobacco, weapons, or fossil fuels.
• Positive screening – Selecting companies with strong ESG practices.
• Thematic ESG investing – Focusing on themes like clean energy, gender diversity, or sustainable agriculture.

Each fund sets its own rules, meaning ESG-labelled funds like sustainability ETFs don’t all follow the same approach. Some avoid certain industries, while others actively invest in companies improving their ESG performance.

Third-party verification and certification

To increase transparency, many ESG funds seek third-party certification. Some common ESG verification providers include:

• Morningstar ESG risk ratings – Rates funds based on the ESG scores of their holdings, informed by Sustainalytics’ research.
• Principles for Responsible Investment (PRI) – An initiative backed by the United Nations that assesses investment firms on responsible investing practices. Asset and investment managers become UN PRI signatories if they commit to integrating ESG factors into their investment decision-making.

Certification helps investors understand how strictly a fund follows ESG principles. However, not all ESG funds seek external verification, so investors need to check each fund’s methodology.

The role of fund managers

Fund managers play a big role in shaping ESG strategies. They decide which companies to include based on their ESG policies, financial performance, and long-term outlook. Some fund managers also engage with companies, pushing for stronger ESG practices through shareholder voting and direct discussions with executives.

Understanding a fund’s ESG strategy can help you decide if it aligns with your investing goals.

Challenges and controversies around ESG

ESG investing is growing, but it’s not without debate. Arguments against include its credibility and flaws in ESG scoring and criteria.

Greenwashing and credibility concerns

Not all ESG investments are as responsible as they seem. Some companies and funds exaggerate their ESG efforts to attract investors – a practice known as greenwashing .

A company may promote sustainability goals while still engaging in environmentally harmful activities. An ESG fund may hold stocks in industries some investors don’t expect, like fossil fuels or mining.

And because ESG labels can vary between providers, it can be hard to compare funds.

Regulators are increasing scrutiny to reduce greenwashing, but ESG claims still require careful review. Certification and third-party verification can help, but they’re not foolproof.

Limitations of ESG scoring models

As mentioned, ESG scores can be inconsistent. A company might receive high ratings from one agency but low scores from another. These differences mean an ESG score doesn’t tell the whole story. Investors may need to check how a rating was determined to understand its meaning.

The evolving nature of ESG criteria

ESG standards are changing as governments, investors, and regulators refine their expectations. Here’s how:

• Some industries once considered ESG-friendly face new scrutiny, such as tech companies with privacy concerns.
• Regulators are introducing stricter ESG reporting rules, which could lead to more reliable data.
• ESG funds are shifting their strategies, with some focusing on company improvements rather than just exclusions.

As ESG investing evolves, new rules and rating methods may shape how ESG status is defined. Investors will likely see more transparency – but also ongoing debates about what ESG really means.

Think beyond the score: making ESG work for you

ESG investing is complex. There’s no single way to define ESG, and different rating systems mean ESG scores aren’t always consistent.

Regulations and reporting standards are evolving, making ESG claims more transparent. But greenwashing and inconsistent scoring remain concerns.

ESG investments aren’t all created equal, and knowing how they earn their status makes it easier to assess their true impact. By looking beyond labels and asking the right questions, you can make informed choices that align with your values and long-term goals.