Challenges in ESG investing, or: I thought it would be clearer now!

The Globe and Mail recently published an article on Why the booming business of ESG ratings may be giving investors a false sense of sustainability

It’s written by Jeffrey Jones and David Milstead. Here are some extracts:

  • Investors around the world are ploughing tens of billions of dollars a year into companies and funds that tout superior environmental, social and governance (ESG) attributes. Many assume they’re doing good for the environment or gender equality as they save for retirement.
  • But there’s growing concern – even among those who make their living in sustainable finance – that ESG’s emergence as an asset class alongside traditional stocks and bonds risks shifting the focus away from the non-financial values it’s meant to promote.
  • At the heart of the confusion is the broad scope of what constitutes ESG investing. The concept loosely covers everything from climate-related business risk to boardroom diversity to workplace safety – three disparate concepts that Tariq Fancy, former chief investment officer for sustainable investing at BlackRock Inc., the world’s largest asset manager, says have been lumped together almost arbitrarily.
  • Mr. Fancy has made waves in the finance industry by arguing ESG investing is “a giant societal placebo” geared more to helping professional investors improve risk-adjusted returns than to promoting the global action required to solve complex, long-term threats such as climate change and inequality.
  • …Mr. Fancy…says the key to better corporate and finance-industry performance lies not in ESG scores, but in strong and deliberate government and regulatory action to enforce standards. Many people entered the sustainability professions to make positive impacts inside and outside their companies and have a sense of fair play. They need to lead the charge, he says.
  • “I think it’s ridiculous for anyone to work in the ESG community and not be arguing in favour of government regulation,” Mr. Fancy says. “It would be like a coach who teaches how to play clean hockey and then they’re okay with there being no referees. You don’t get any benefit from playing clean unless someone’s enforcing it.”

Only through wishfully fuzzy thinking though could any of this somehow seem surprising or debatable – we’ve made a similar point in this blog more than once. Just as a company’s preparation of IFRS-compliant financial statements is no guarantee against various crummy day to day financial practices, a greater embrace of sustainability reporting can’t guarantee that all reporting entities thereby become virtuous, or, crucially, that even if they do all become broadly virtuous, that their individual efforts will total to the aggregate change required to avoid severe disruption. The effects of the war in Ukraine underline yet again how short-term antipathy to rising oil prices (or, more broadly, to anything that smacks of long-term and hence unreliable social engineering) will often count for more than all the scientific consensus in the world. In the US, any electoral swing back toward the Republicans (as seems inevitable before the end of the year) would at best slow down initiatives designed to counter climate change and more likely blow them up entirely. Even in relatively progressive Canada, Pierre Poilievre, the leading contender in the current race for leadership of the opposition Conservative Party, would scrap the (hardly crippling) federal carbon tax, just for starters. One could go on, country by country; even where such views don’t hold the majority, they’re powerful enough to dilute the capacity for action. And there’s not even a vague prospect of that getting any better. On the contrary, it’s increasingly evident how the rejection of any sort of scientifically-backed restriction on one’s “freedom” is held up as a sign of virtue – put another way, the more strongly and eloquently the identified “elite” argues for something, the more passionately it apparently needs to be denounced (masking, vaccination, and other anti-Covid measures being a prominent recent example).

The notion that ESG investing and related disclosures are “geared more to helping professional investors improve risk-adjusted returns” than anything else shouldn’t be seen then as some kind of snarky denunciation, but rather as a literal summary of their core purpose, and a rather grim one, given that truly addressing climate change and other societal problems almost certainly entails accepting a long-term reduction in returns  (as we recently noted, it’s a rare company that doesn’t ultimately contribute either to environmental pillaging or to increasing inequality and accompanying social tension. The Globe and Mail article makes lots of good points about the fragmented nature of the current landscape, and the difficulty in knowing what a particular ESG rating actually means or what should be done about it. But the limitations of the process would better be seen, as people say, as a feature rather than a bug – problems with the ratings might be viewed, in the words of one of the article’s commentators, as “breadcrumbs” that spark further discussions and contemplation. Because immaculate standardization of ESG disclosure will likely only come at the cost of a vast, expensive, and self-absorbed compliance machine that may overwhelm whatever frail inherent potential such information possesses…

The opinions expressed are solely those of the author

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