Anti-ESG sentiment is on the rise. As the global economy weakens daily, investors are debating how much value they gain from paying attention to environmental, social and governance issues. For many, the chance of improving the real world is worth the risk of losing a few basis points of performance — or could even make them money. Others insist the whole idea is bunk.
Finance has joined the ESG movement in great volumes, to the point where responsible investing is, if not the norm, at least very much part of the mainstream.
But is it genuinely having a positive impact on climate or social issues — or just revelling in a festival of greenwashing and false labelling?
In the world of international development — for which the UN’s 17 Sustainable Development Goals, which also guide much of the ESG movement, are like the Ten Commandments — there is ample precedent for something being widely accepted, but later rejected as the wrong approach.
It was once International Monetary Fund and World Bank policy to implement structural adjustment programmes, imposing free market economic reforms on developing countries in exchange for funding. These schemes are now deemed by many to have done more damage than good.
In Africa, for example, policies to integrate the continent into the global economy failed because of a boilerplate approach. The same economic remedies were prescribed, without due attention to individual countries’ ailments and needs — or the policies’ impacts.
There is an argument to be made that ESG investing, too, ignores real world scenarios and imposes an ideology unthinkingly.
ESG investing may have worthy intentions, but it is important to question its methods and what they mean for investors.
“If I want to say that I am for or against ESG, first I need to define what I mean by ESG,” said Eila Kreivi, chief sustainable finance adviser at the European Investment Bank in Luxembourg. “If you have two people in the room there are three opinions about what ESG is. We have to agree what we mean before we decide whether we are for or against it, because it’s all over the place.”
The World Bank issued its first green bond in 2008, responding to demand from Swedish pension funds for an investment that would protect the climate. Three years earlier, the term ESG is said to have been coined in an International Finance Corp conference report called Who Cares Wins.
Since then, there has been something of an ESG consensus in Washington — and increasingly, in the wider capital markets.
Two camps form
At the COP26 conference last year in Glasgow, a coalition of banks, investors and other finance companies with more than $130tr of assets pledged to support net zero emissions in their investments by 2050. This was seen as real progress — finance to the rescue.
But ESG isn’t for everyone, especially in the US. Four years of the Trump administration empowered an anti-‘woke’ movement that rejected anything the Democrats supported, including attempts in financial markets to fight climate change or show responsibility to disadantaged human beings.
States like Florida and Texas are at constant and rising risk of hurricane damage. Nevertheless, anti-ESG sentiment has risen there so much that their legislatures have passed laws forbidding the state from doing business with financial firms that ‘discriminate’ against fossil fuel companies.
In Brazil, President Jair Bolsonaro has rejected ESG and pulled support for many initiatives. Worse, he has allowed deforestation and fires to worsen in the Amazon rainforest.
The Russian invasion of Ukraine has sparked an energy crisis in Europe that is threatening a harsh winter. Countries at risk of gas shortages may turn to coal, despite years of pledges to move beyond fossil fuels.
And within the European Union’s finance sector itself, layers of regulation, guidelines, recommendations, principles and ratings are causing ESG fatigue. Given the perilous state of the economy, investors are asking if the benefits are worth the effort — or whether they exist at all.
Fatal conceit?
Corrado Pistarino, chief investment officer and chair of the climate risk forum at Foresters’ Friendly Society, a small UK insurance company, questions how much value can really be gleaned from an ESG strategy.
“I've been working in this sector for years,” he said. “My experience tells me that it’s very difficult to make money, it’s very difficult to generate alpha and it’s very difficult to find yourself in a position in which you have an information advantage on your competitors. My baseline assumption is that most of the information is already captured in the prices you can see. Most likely, in terms of performance, I will be at best tracking the index.”
Pistarino argued that an investor restricting itself to companies with better ESG attributes inevitably reduced portfolio diversity by favouring and disfavouring certain industries.
“Of course, if you produce cement you will have a terrible ESG rating, but we need cement,” he said. “The economy has a lot of building blocks, and each building block is equally important. It’s important to have some cement if you want to build back Ukraine.”
Another vocal voice against the ESG movement is Vivek Ramaswamy, co-founder of Strive, an asset manager in Ohio, which promotes investments that it do not push political agendas.
Its US Energy exchange-traded fund and recently launched Semiconductor ETF are determinedly anti-ESG in conception. According to Ramaswamy “the real problem, as I see it, is not that BlackRock is divesting from oil and gas, but that they’re investing in oil and gas firms and changing the purpose of what these firms are supposed to do”.
Changing the fabric of companies, especially in energy, would have disastrous ramifications, he argued.
“The danger of getting fossil fuel companies to transition away from being fossil fuel companies is that we have systematic underinvestment in fossil fuel production, which leaves us shorthanded when there’s a massive supply and demand imbalance for global fossil fuels, as we’ve seen this year,” Ramaswamy said.
“The fatal conceit, as Friedrich von Hayek called it, is to think that we can know in any central model, government or private sector, what the right ways are to settle the fundamental and complex questions that cause us to suffer in otherwise unpredictable ways, such as the global energy crisis we’re facing now.”
The fact that Europe is still financing Russia’s war machine because of its inability to produce its own oil and gas was, he argued, a wake-up call to what really constitutes “playing it safe”.
Morals and risk
At the other end of the spectrum are investors convinced they must think about more than the bottom line on the quarterly report — either because it is morally right, or simply out of financial prudence.
Like the Swedish pension funds in 2007 that called for green bonds, these actors want their capital to help develop the world. They believe their clients expect it, too. Surveys and hard evidence suggest that many savers — especially younger ones — do want their cash to be invested responsibly.
Triodos Investment Management, a Dutch asset manager, handles $5.7bn invested in the real economy for social and environmental benefits, with full transparency.
“We are ethical investors — we do impact investing because we think the world should become more sustainable. That’s what our clients expect from us and that’s how we invest,” said Hans Stegeman, chief investment strategist at the firm. “I completely understand that some people think differently. But even if you think differently, every investor should take all the risks into consideration.”
What Triodos does, he said, “is look from the inside out perspective at how we can make the world a better place, which is completely normative, ethical, and you could say it is complete rubbish, but that’s what we do,” he said. “If you don’t want to do that, you should still see ESG factors as risk factors on sustainability. It’s your proprietary duty as an investor to take all the possible risks into consideration, so that’s why I don’t get the [reluctance] in the US.”
Even if you don’t care about climate change, many ESG proponents argue, it is clearly happening. Droughts, fires and floods will intensify, and affect investments. Bad governance is always a risk. Investors can leave their ethics at the front door, but still take ESG into consideration and include it in their risk models.
Voices of doubt
In Europe, investors are now required, not to take ESG into account, but at least to declare their approach to it, and disclose considerable ESG information about their investments.
The US is in a very different place. The Securities and Exchange Commission introduced proposals for a climate disclosure regime in March, but they have yet to be ratified.
A backlash against them has spread across the US financial markets. There is even opposition within the SEC itself. Republican commissioner Hester Peirce, for example, has expressed concerns about the proposals.
“There are different strands of the anti-ESG sentiment, some of which are a direct response to SEC climate rule proposals and investor company rulemaking,” she told GlobalMarkets. “People are asking the question of whether, when money is being managed, it’s being managed for the benefit of the investor — the client — or is it being managed for the benefit of the asset manager?
“One of the things our rules are looking to address is this concern that advisers are not telling their clients how they are managing their money and whether they are representing that accurately or not,” Peirce said. “Clients asking questions is good and healthy. ESG is so nebulous, but if someone claims to be managing with an ESG strategy, they should explain what that is, and then let the client decide whether they want it or not.”
Another country experiencing ESG pushback is Brazil. However, it is not domestic regulation worrying investors there, but US ones. Gustavo Santos, head of ESG at Alvarez & Marsal in São Paulo, said his clients — mostly private equity companies — were more concerned about the SEC’s proposals and the EU’s Sustainable Finance Disclosure Regulation than domestic laws.
“They are afraid that the capital flow from Europe or US might diminish in Brazil if they do not comply to these regulations,” he said. “Clients are not really concerned about the environmental aspects, just capital flows.”
Safety and soundness
The US bank regulators, the Office of the Comptroller of the Currency, Federal Reserve and Federal Deposit Insurance Corp, also issued guidance in a coordinated way around the same time as the SEC XXX, but were careful to distance themselves from promoting climate action for ethical reasons.
They agencies said then, and have since repeated, that climate poses risks to the banking sector — but that this is not the same as banks setting carbon targets or pushing against fossil fuels. The regulators do not want to step out of their mandate of protecting the US banking system.
“Consistent with the draft principles and our legal mandate, the OCC is laser-focused on the safety and soundness aspects of climate change risks,” said Michael Hsu, acting OCC comptroller. “Unlike regulators in some other jurisdictions, we do not (yet) have a mandate to help meet carbon reduction targets. This means we cannot take supervisory measures specifically designed to accelerate the transition to a carbon-neutral economy, such as limiting credit to fossil fuel companies.
“Rather, we are focused on large banks’ climate risk management capabilities: identifying, measuring, monitoring and mitigating climate-related exposures and risks. Weaknesses in risk management could adversely affect a bank’s safety and soundness, as well as the overall financial system.”
The federal view is straightforward: safety and soundness come first.
A fork in the road
In Florida, however, regulators are going in the opposite direction. In August, Governor Ron DeSantis, a potential presidential candidate, approved a rule that would prevent the state pension fund from even considering ESG when making investment decisions, suggesting that ESG policies “are dead on arrival in the state of Florida”.
Florida was not the first state to take action like this and will probably not be the last. So far, 17 Republican-leaning states have introduced anti-ESG legislation.
Far from being treated as a neutral matter of risk management, ESG has become politicised in the US — another battleground in the culture wars.
Financial punches are being landed. BlackRock — a member of the United Nations’ Glasgow Financial Alliance for Net Zero — has reported losing more than $1bn of asset management business in Republican states so far. States including South Carolina and Utah have dropped the world’s largest asset manager on the grounds that its CEO Larry Fink is too heavy handed with his green pronouncements.
Which side is being truer to its fiduciary duty to its ultimate investors may never be settled, because each interprets this duty in a different way.
But markets will have the last word as to which turns out to have been the wiser investment strategy.
“You can call it whatever you like — woke, ESG, or just doing your normal financial analysis with risks and expected returns — but to me, saying that you should not invest in the green transition at all is stupid,” said Kreivi at the European Investment Bank.
“Some governor in the US may think something, but if the whole world is against him then they have to go with the flow, with what the best investment is, because if you’re the only one in the world investing in brown coal, despite what you think, you’re going to lose. Don’t fight the trend and make it your enemy. If I’m a retail analyst working for an asset manager, I don’t need to believe in Santa Claus, but I still need to look at the Christmas sales.”