Updated: Nov 12, 2020
"There is a revolution in finance going on’ Gillian Tett, chair of the editorial board of the Financial Times, exclaims on her branded column “Moral Money”. This “revolution” is bringing sustainability to the forefront of investment and corporate behaviour by considering environmental, social and governance (ESG) principles in portfolio selection and management. And she’s right, this rising tide of ESG followers has globally become salient with the likes of HSBC, CFA and even Black Rock becoming ESG advocates, which in turn has caused the world’s largest corporations to jump on the ESG bandwagon. That bandwagon is currently valued at $32 trillion, having already risen from $17.5 trillion in 2018.
The ESG fan club is currently framing it as the vehicle that can help decarbonise the economy – but can this explosion of wealth truly engender a just energy transition? As it stands, The International Panel on Climate Change estimates that $2.4 trillion - approximately 2.5% of global GDP - would need to be invested in the energy system every year through to 2035 in order to limit climate change to 1.5 degrees above pre-industrial levels. As public finance amounts to only 15% of the financing required to meet decarbonisation targets, we need to unlock this sort of private finance, and fast.
Where did it come from?
Originally rooted in ethical investment from religious practises, ESG then germinated from within the Social Responsible Investment Movement between the 1960 - 80s in America. However, ESG emerged in the 21stcentury as a re-imagination of capitalism, or “conscious capitalism”, as the term is coined for the first time in the “Who Cares Wins” paper researched by a joint initiative consisting of 20 financial institutions from 12 countries across America and Europe. This initiative, led by the United Nations Secretary Kofi Annan, recommended the application of ESG principles within economic institutions in an increasingly globalised world.
How does it work?
ESG stems from stakeholder theory which believes the pursuit of maximising all stakeholder wealth will lead to the maximisation of shareholder returns. The idea that ‘what gets measured, gets managed’ is crucial to the ESG integration process as it is predicated on the measurement of non-financial ‘material factors’. It essentially helps speculate the future performance of a company based on the corporation’s management of negative externalities. What issues are deemed ‘material’ to the final score vary according to the industry and the markets in which the company operates in as regulations and technologies differ according to regionality. ESG valuation has a binarizing power as it can either highlight the companies that are leading market decarbonising transformation, and therefore urge others to change accordingly, or incentivise by financially penalising corporations. The Bank of America reported that 24 ESG controversies caused a total loss of $534bn off the value of unnamed US companies in the past five years.
Currently, the process of ESG valuation lacks standardisation and transparency and enables investors and financial analysts to interpret or manipulate data for their own prerogative. One could use either positive or negative ESG data to support their preconceived notions of which stocks are financially profitable instead of using an objective assessment. Stefan Leins, an analyst in the Swiss Bank (a signatory of the initial ESG report), described a worker who asked whether his colleague could provide him with a positive ESG fact about BMW so that he could recommend to his client something he thought was already financially promising.
Nevertheless, recent media attention has highlighted the mechanism’s ability to counter the short-termism endemic to our financial institutions. This is questionable as studies that showed ESG shares outperformed others - for example an HSBC report showed a 7% increase - are tainted as many of these funds and indices naturally deter from oil and gas. These kinds of indices therefore gained a huge advantage during the oil demand crisis and the crash into negative pricing, and it is still too early to tell whether ESG can instigate a genuine shift towards long-termism.
Who are the “winners, who care”?
ESG investing allows for capital accumulation to become the crux of political capital as the choice in stock becomes a political vote, but this capital is concentrated in an investment industry in which the top five asset managers holds 22.7% of externally managed assets and the top 10 holds 34%. The implication that the “losers” are those who don’t place stakeholder wealth front of mind, conceals the real “losers”, who are those excluded from investment streams. The morning star reported emerging markets represented no more than 10% of global equity indices, therefore, in reality, ESG investment perpetuates a Western-centred wealth cycle in which the “integration of ESG” becomes a green-washing mechanism which allows for institutional investors to invest in the same corporations and fossil fuel industries without diminishing the fission between industrialised and developing nations.
ESG reporting has allowed fossil fuel giants such as Exxon, BP and Shell to remain key cogs within this system of “conscious” capitalism, as this element of environmental transparency is regarded as a nod in the right direction. The Carbon Disclosure Project rewarded Shell a B earlier this year despite having spent only $2 billion out of a proposed $4 - 6 billion plan between 2016 and 2020. This continued investment is reflected in the FTSE100 with Shell and BP still composing 15% of holdings.
Whilst the fossil fuel industry is able to greenwash their image, BlackRock and other institutional investors reap the same benefits whilst also accruing wealth. At the turn of this year, Larry Fink, the CEO of BlackRock (worth $7.4 trillion AUM), pledged to ‘integrate ESG considerations into all active decisions in 2020, and to divest from fossil fuel companies that generate more than 25% of their revenues’. Only three months later, Black Rock refused to support the vote for the alignment of environmental resolutions to the Paris Agreement Accord with two Australian oil companies, disregarding the unprecedented 43% of investors who did support it. Whilst BlackRock’s pledge is admirable, their carbon locked-in portfolio has 3.27 bn barrels of oil, 1.35 bn tons of coal, and 21.7 cubic ft of gas fossil fuel reserves under management.
What’s more, Black Rock has been exploiting and profiteering off the rise of ESG through the proliferation of low-cost Exchange Traded-Funds. Passive Investors seeking to decarbonise their portfolio are drawn in through titles such as ‘low-carbon funds’. In 2018, Larry Fink estimated that assets in ETFs incorporating ESG factors would grow from $25 billion to more than $400 billion in a decade, in which BlackRock had nearly 25% of the market segment worth $7 billion. This year, the U.K’s top best-selling fund was Black Rock’s £1.6 Billion World Low Carbon Equity Tracker fund that received £702 million in the first few weeks of the year. And of course, the top 10 holdings of the fund include the likes of Amazon, Apple, Alphabet, Johnson and Johnson and Microsoft, and a brief glimpse at other ESG indices will show you that they are also unfairly privileged to high capex companies in the West, and favour large tech companies. This is not to discredit the role the technology sector has to play in engendering an energy transition; industry currently takes up 32% of world total energy consumption and these large tech giants are rightly pledging for carbon neutrality, but it problematically coalesces decarbonisation with wealth, and is shifting emissions to emerging, or lower income markets. This is seen on two accounts:
Firstly, these tech giants and corporations’ decarbonisation pledges often use offsetting schemes which further entrench economic and Co2 emitting inequities between wealthier and lower income nations. ESG investment perpetuate a cycle in which corporations receive investment, expand business operations, and with increasing capital, offset carbon from their nation to an agricultural, or carbon sink project in a lower-income nation - thereby placing the responsibility to tackle climate change elsewhere.
Secondly, global corporations, like Apple, have decentralised and fragmented supply chains, where carbon intensive activities are outsourced to emerging or lower income nations. This division is captured in consumption-based accounting (consumption = production – exports + imports), which provides a more honest global picture as opposed to the territoriality-based accounting of the Kyoto Protocol. Although the Kyoto Protocol shows an overall decrease in emissions, consumption-based accounting shows that wealthier nations are outsourcing their emissions to middle income nations as their economies shift from manufacturing to services-based. This outsourcing of emissions comes in the manufacturing of, for example, electronic devices and smartphones which are manufactured in Asia but consumed in the US and Europe. Whist the wealthy elite enjoy high carbon consuming livelihoods, and become less dependent on fossil fuels, they offset their carbon elsewhere, thereby restricting developing economies who remain fossil fuel dependent.
ESG is a mechanism that accepts the capitalist structures we reside in and continues to amalgamate wealth in Western institutions and deepen the fission between developed and emerging economies. On a fundamental level it needs a standardised process before it can start creating a global impact. Although ESG has made investment institutions and corporate powers learn different steps; it is still the same dance.