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Team ESG has had a tough quarter.
The sustainable investing space heard a cacophony of critiques these past months, as well as its first major investigation by the U.S. Securities and Exchange Commission. Those on the green finance frontlines have been sharing with me that the critiques fall somewhere on the spectrum from merited to misguided.
The ESG pushback isn't just from regulators. It's coming from the mainstream media and NGOs from around the world, both of which have called out corporate claims and investment funds rooted in ESG as exaggerated, or even fraudulent.
The increased scrutiny is a sign that ESG is having a significant impact.
What the critiques have in common is that, according to most ESG professionals I’ve heard from, they are welcomed.
The increased scrutiny is a sign that ESG is having a significant impact and the current pushback isn’t necessarily a hindrance to meaningful progress. Instead, it could actually be a boon to the evolution of ESG and its impact.
So, the question is: Where are we now and how are ESG leaders digesting this pushback? I’d like to share some takeaways of what I heard from folks across the space these past few weeks in the hopes you find it helpful for the work that lies ahead.
Waking up the CEO
Desiree Fixler, former head of sustainability at embattled asset manager DWS, told me that when it comes to ESG’s potential to change the world, it’s "just not a zero-sum game."
"I don’t disagree with all of these critiques, but this also isn’t binary. ESG investing is not simply a means of propping up the status quo," as Giridharadas’s "Winners Take All" or Tariq Fancy’s "Secret Diary" — both great reads — posit. "I do believe, and even [Milton] Friedman said, that elected governments are the ones who shape nonfinancial frameworks for society. Government has to lead first, but I still do believe in the power of ESG investing. My main issue is about misrepresentation."
Without the fangs that regulatory enforcement affords, ESG is experiencing the result of a problematic financial nexus: clear investor demand for "green"; poorly defined rules and accountability for those investment products (for now); and the say-anything culture that it fosters. As Fixler told me, "With the lack of rules, the field of exploitation will just remain wide open."
Fear does have the effect of keeping folks honest, but one of Fixler’s takeaways from her recent experience is the opposite for ESG leaders: "You should feel much more confident to speak up right now — your CEO is going to listen."
ESG as education
Some of the loudest critiques have insinuated that the ESG industry claims it can save the world, but that it’s ill-equipped to do so.
ESG analysis and investing don’t purport to be a panacea for the climate crisis. Rather, it is a foundation for refashioning capitalism into a system that promotes social and environmental well-being while delivering sustainable returns to investors. Undoubtedly a tough task, but not the pipe dream or PR campaign it’s been caricatured to be.
Where ESG has provided value to the market is by educating it. As Aniket Shah, global head of ESG and sustainability research at Jefferies, told me, "We have a financial system that has never worried about negative externalities…. ESG has been helpful in educating investors about these material risks in a way that nothing else has. Like the Fed now thinking about climate stress testing? ESG has undoubtedly been crucial to socializing these types of ideas."
"Empirical data shows that, on the whole, ESG integration adds value," Elizabeth Lewis, managing director of ESG at Blackstone, told me. Still, she says, it’s a lot easier to measure assets under management than changing perceptions in the investment industry of value, risk and materiality, but you don’t get one without the other. "As ESG professionals, we take on important ESG issues that are, on the surface, not financial and translate them into financial metrics."
Chris Hagler, practice leader in EY’s Climate Change & Sustainability Services business, sees the ripple effects with corporate issuers. "Within the last two years, investors are asking more questions about ESG performance. This year I have clients with buy-side analysts reaching out with questions like, ‘What’s your water-use ratio?’ I think investors are asking these questions because so much has been done in ESG to make evident the links between issues like this and financial performance."
Unstoppable and important
One sustainable finance researcher asked, "You think maybe the issue here is that the folks constructing the funds aren’t the same folks who are marketing them?"
When I surfaced this in conversation with some asset managers, I got some nodding heads. But Chris McKnett, co-head of sustainable investing at Wells Fargo Asset Management, had two particular takes I’d like to leave you with:
"I think the market and regulators will flush out the blatant greenwashing, and the inadvertent greenwashing will be resolved by the markets, too. I think you’ll see a lot more rigor around how intended outcomes are framed, and that you’ll soon see greater involvement from folks in compliance and legal with increasing acumen around ESG investing." So, the control environment in the investment community is quickly catching up.
And the bigger picture?
"Forget about AUM here," McKnett said. "It's about the response from business and the shift in the seriousness and the depth that's informing strategy, business planning and capital allocation in the real economy. I firmly believe that sustainable investing’s impact is about the bigger base of assets that maybe don't have ESG as the investment objective per se but are using it to conduct more complete investment analysis. The subtle pricing effect that has, the way in which it's communicated to companies through that pricing effect or through engagement, is an unstoppable and really important trend."