Is it time for ESG to grow up?

24 Aug 2021 | An ex-BlackRock head leads ESG backlash; investors and businesses face impact accounting revolution; money earmarked for good languishes under weak regulation. Plus, is it time to think beyond ESG?

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📣 Ex-BlackRock sustainability CIO Tariq Fancy published a three-part essay taking down ESG. TL;DR: Finance will always go for profit over purpose. ESG is more than a placebo: It’s a dangerous distraction, delaying government action.

🌍 This is all part of a bigger ESG backlash against “hype and woolliness,” warns the FT. To prove sustainability has substance, businesses must adopt the principles of impact investing and be honest about their measurable, material impacts.

🧮 They may be forced to if, as Sir Ronald Cohen predicts, we’re due an impact accounting revolution rivalling that of GAAP. Unlike Fancy, he argues capitalism must reform itself, as policy can’t fix the damage caused by unbridled profit hunting.

🛢️ It was easy to wave the green flag when ESG-friendly sectors such as tech were outperforming. The real test may have finally arrived. Will cheap, dividend-paying oil stocks tempt investors concerned about an overvalued market?

🇳🇴 Not Norges Bank Investment Management. Norway’s wealth fund—the world’s largest—should be handed a new mandate “to better handle climate risk” and pursue Paris Agreement-aligned strategies, according to new recommendations.

🔬 Easier said than done. The report finds climate risk is poorly understood for industries other than oil, particularly finance. As the biggest risks are unexpected and idiosyncratic, they recommend a company, rather than sector, approach.

🚨 $25trn of the global $35trn invested sustainably isn’t doing much, says Bloomberg. In the absence of regulation, most money earmarked for good is allocated to ‘ESG consideration’ strategies, which must factor in—but not act on—ESG data.

❓ Is SFDR a help or hindrance? EU rules may muddy the waters, reports Reuters, as vague definitions of sustainability create confusion. As evidence, Reuters points to a slew of high-profile, well-marketed Article 8 with limited claims to sustainability.

Util in the news

🧐 How sustainable are your ESG investments? Interviewed by The i newspaper, Patrick Wood Uribe says arbitrary methodologies and siloed ratings, coupled with booming demand, are leading to allocations that might surprise end investors.

⚖️ Writing in Environmental Finance, Patrick Wood Uribe compares the impact of retail brokerages like Robinhood with traditional asset managers. To what degree does each address individual financial, as well as global social and environmental, needs?

Time to think beyond risk

For which sector does global warming pose the biggest risk? The answer might surprise some.

A government-commissioned report, published last week by a group appointed by Norway’s Finance Ministry, recommends Norway “change the mandate” under which its $1.4 trillion wealth fund operates to “better handle climate risk.”

To do that, Norges Bank Investment Management will first need identify where the risks are lurking. And that’s no easy feat.

“Risk is about the unexpected. I think one needs to be very careful in assuming that the risks are greatest where they’re most obvious.”

Counterintuitively, the energy sector is unlikely to throw up any nasty surprises: the market has already taken most climate risks into account. Martin Skancke, the report’s lead author, tells Bloomberg the real risks are to be found in industries in which the fallout of climate change is still poorly understood.

Of which is that most true? Finance.

Predictably terrible doesn’t mean less terrible

There’s an irony in talking about the urgent risk of global warming without talking about the environment itself.

A common criticism levied against ESG investing is that it focuses only on the subset of material risks that could impact a company’s enterprise value. Relatively little thought has gone to the effects a company has on the world.

In fact, ESG may be the only corner of investing where risk is assessed in a silo.

That the market has priced in climate risks to energy companies shouldn’t mean the financial relationship between fossil fuels and global warming is dismissed. The sector has a significant detrimental effect on the environment, which, in turn, catalyses climate risks across all the industries in the global economy.

At what point does the market price in the risk fossil fuels have on the environment?

Even if climate risks don’t disproportionately influence energy, energy disproportionately influences climate risks
Measuring impact is more straightforward

If, as pundits such as Tariq Fancy and Sir Ronald Cohen have recently argued, the world has been held back by thinking in terms of risk rather than risk and impact, the good news is that the latter is well within our reach.

Skancke highlights the fact risks are idiosyncratic and unexpected. No wonder ESG data is fiendishly complicated and analysis difficult to apply at scale: in fact, he suggests investors take an individual company, rather than sector, approach.

Impact, on the other hand, is far easier to assess uniformly and at scale. It has long been assumed that it’s tougher to measure the impact a company has on people and planet than it is to measure the impact of people and planet on a company’s enterprise value. That’s nonsense.

For impact, there are really only two types of metrics that matter. Once you understand the way in which a product (adjusted for the region in which it’s sold) affects a sustainability theme, you can understand how any company and any sector is influencing the world around it.

Benefitting from a top-down approach and fewer idiosyncratic surprises, it becomes much easier for impact accounting to scale. Perhaps it will soon address that $35 trillion earmarked for good investments that is, in fact, doing no good at all.

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