The ESG veil

Attempted persuasion of the financial markets.

More or less, Environmental, Social, and Governance (ESG) is an evolution from Corporate Social Responsibility (CSR) which is doing good for the sake of good and originated in corporate philanthropy. CSR was tired, not really that followed and it didn’t have influence. Notably, CSR wasn’t quantitative and influential enough in the financial markets. A new term had to be resurrected.

UN’s 2004 The Global Impact report Who Cares Wins – Connecting Financial Markets to a Changing World recommends the financial industry to integrate ESG issues in financial analysis, asset management, and securities brokerage is where the term was really set into motion. It was more so promoted/designed to achieve UN’s agendas. By 2005 ESG started to go mainstream with a more data-driven approach to measure the company’s impact on society – or so the claim.

CSR isn’t out but ESG is definitively the more used ‘corporate feel good’ marketing tag and most are so confused that they are using them interchangeably. Mostly because CSR isn’t as recognized by younger investors and managers. To a greater extent, ESG takes advantage of the “Environmental” part of marketing as it feeds off the news and current events.

ESG rating is based on the impact of the changing world (environment) on a company’s profits and losses and doesn't measure the impact of the company on earth and society. Most people probably thought it was the foremost. After all, it was all about tackling environmental challenges.

MSCI’s “ESG ratings what they are and not” describes it as financial risks to a company’s bottom line with this example:

“For instance, to determine whether a maker of semiconductors risks running out of the water it needs to make chips, investors may consider whether the company operates in a locale that requires it to conserve water. They also might consider the prospect of regulation on water usage, potential conflicts with the community, and whether management is taking steps to address those concerns.”

Most people will also be surprised that there isn’t an ESG ranking standard either. This is why you see oil&gas companies having high ratings and tobacco companies getting higher scores than Tesla. It has nothing to do with climate change or sustainability yet it’s being promoted as such. Some companies did start adding extra tools to measure environmental impacts and prospectuses mention “sustainability” many times without any explanation as to what and how things are actually measured.

Asset managers already review and have internal assessments and interviews for the Governance of most companies that they allocate capital. The Social aspect is generally the least considered and hardest to quantify as a measurement aspect of a company’s performance. The relationship between the Environment and companies is a closely reviewed part of the risk assessment specifically tied to forecasting on the regulations side.

There is nothing really new offered by ESG funds nor do they offer any additional benefit that leads to performance. They are more expensive in general as well it seems. Norway’s Sovereign Wealth Fund has called for the chaotic landscape of the ESG rating industry to be overhauled. Morningstar has removed the ESG tag from over 1000 funds and Vanguard pulled out of the Net Zero Asset Managers Alliance.

Asset managers are leaving or want regulation on ratings because of the political influence and range of variability in rating assignments. Asset managers have a fiduciary duty to clients and that leaves them holding the risk. Fiduciary duty is the hurdle that is being tried to overcome and the UN and other pop-up organizations have already tried to reason how moving capital based on climate goals isn’t out of line.

ESG will keep getting massaged to influence the flow of capital to intended goals. After all part of the trillion-dollar opportunity often touted with renewables refers to the trillions of dollars under asset management that various institutions have signed various pledges to.

UN’s Principles For Responsible Investment, Net Zero Asset Managers, UN’s Race to Net Zero and other spin-off initiatives will continue, grow, and change until the next leveraged sweet spot is found.

The ultimate goal is to shift capital allocation - which isn’t hidden. It has to be done delicately and over a long period of time as investors and pensions are other people’s money who expect and need returns. This is money that hasn’t been widely accessible for political influence but they think they can mobilize it for their causes.

It’s audacious, and ESG is what it’s being attempted under.