The KIIDs are not alright

6 Sep 2021 | This week, the DWS greenwashing probe set off dominoes; Cathie Wood's new ARK Investment Management LLC fund underscores a dilemma at the heart of the sustainable transition; climate emerges as the most urgent ESG factor. Plus, which SDGs are the greatest casualties of today's blanket approach to ESG?

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🚨 Post-DWS probe, asset managers fear exaggerated claims about sustainable investments (read: greenwashing) will become a “miss-selling scandal,” reports the FT, as poor data and conflicting standards open the door to claims of fraud.

🃏 A domino effect certainly looks likely. Last week, the SEC signalled disclosure requirements are coming. To date, there’s been no consensus on what constitutes ESG, making it an easy, risk-free sell. Downside risks may see institutions retreat.

☂️ Responding to the ESG backlash, MSCI CEO Henry Fernandez argues regulation won’t work because the range and subjectivity of E, S, and G make ratings variability inevitable. Which begs the question: Has the umbrella term had its day?

🌎 If it has, measurable climate impact may emerge as the most urgent investment factor. Fernandez suggests climate change, more than ESG, will herald capital reallocation and asset repricing. In a new survey, Altis finds investors agree.

🧮 The ECB is warning lenders to prepare for climate change stress tests next year. The regulator has requested data on how bank balance sheets will fare through 2050, as well as the link between profits and carbon risk in their portfolios.

⛵ Finance’s hottest trends collided last week, when Ark Invest’s Cathie Wood filed to launch a passive ESG fund. The Transparency ETF will screen out companies with poor ESG scores, including oil, metals, and—unusually—banking.

⚒️ That metals screen, juxtaposed with Wood’s famously bullish Tesla position, draws attention to a discomforting truth: clean tech requires a lot of metal. Cue concerns about a) greenflation, and b) mining ethics. (Can Blockchain solve the latter?)

🚩 The ESG bandwagon offers accounting firms two opportunities: more business and a chance to rebrand the profession. As the Big Four jump on board, however, some partners warn of a backlash if they fail to live up to the standards they promote.

⛔ Dozens of investment powerhouses failed to meet the UK’s new stewardship code, which sets standards for asset managers and pension schemes to create “long-term value for clients and beneficiaries leading to sustainable benefits for the economy.”

Util in the news

🗞️ “It’s hard to claim funds are making a meaningful social or environmental contribution when, in many cases, the only significant difference between an ESG and non-ESG product is its name." Speaking to Ignites Europe, Patrick Wood Uribe shared his thoughts on recent criticisms of ESG.

🎙️ Capital allocation is one of the most effective weapons against climate change, but only big data can catalyse sustainable investing at scale. Sign up to this year’s Sustainable Investment Forum North America to catch Patrick Wood Uribe's panel debate about the role of fintech in the transition to a low-carbon economy.

The most important ESG factor is its biggest victim

Has ESG had its day?

Recent events suggest so. First, there was Tariq Fancy’s essay deriding ESG as a “dangerous distraction” from real policy. This was swiftly followed by a US probe into DWS’s sustainability claims amid greenwashing accusations.

It’s been christened the ESG backlash. What comes next?

Time to retire the term ‘ESG’

Interviewed by the FT’s Moral Money this week, MSCI chief Henry Fernandez argued that regulation isn’t the answer because the range and subjectivity of E, S, and G factors make ratings variability inevitable and standardisation impossible.

We’re not convinced that measuring E and S factors is a matter of opinion (which is why we defer to peer-reviewed conclusions as the basis for our analytics). But a bigger problem with the methodologies employed by most ratings agencies is the way in which scores are aggregated. No matter how objective or subjective the conclusions, rolling them into an aggregate score distorts the data—potentially rendering it meaningless. A company might get a high aggregate score despite having a significant detrimental impact on one social or environmental area. (It’s complicated by the inclusion of governance, which ostensibly measures something totally different.)

We need to evaluate ESG factors in silo

To an extent, Fernandez draws the same conclusion when he points to climate as having become “its own product line” within ESG: one that “is going to be much bigger” thanks to the limited time we have to mitigate a global climate catastrophe.

We use the UN Sustainable Development Goals as a framework because they allow for more nuanced perspective of a company’s real-world impact, yielding holistic insight into the myriad positive and negative effects it could have on a comprehensive system of interlocking sustainability concepts.

Recently, we analysed the SDG performance of US sustainable funds relative to the total US fund universe. The results, shown below, are sobering.

Positive and negative impacts of US sustainable funds (green and red boundaries) relative to all funds (black dotted lines). We describe a sustainable fund as one that has sustainability, impact, or ESG factors in its prospectus or other regulatory filings. All holdings are as of Q1 2021. 
There are 17 goals, five of which pertain to environmental impact. On a net basis, both the total and sustainable fund groups had a positive impact on economic, slight positive impact on social, and negative impact across all five environmental goals. While 77 of the 281 sustainable fund names contain the terms ‘green’, ‘clean’, ‘climate’, or ‘sustainable’, a mere four have a positive impact on the environmental SDGs.

In short: No matter whether you go with an ESG fund or not, it’s likely that your capital is contributing to environmental degradation. The difference is minimal; the outcome still bad.

Policy and perspective are key

Current efforts to ‘green’ the economy centre on achieving an energy transition in a few decades. That’s naively optimistic. Renewable tech development is hindered by a material bottleneck, and, in any event, green funds can’t all pile into renewable technology (one of the mere four funds to have a positive impact on the environmental SDGs was recently forced to rebalance amid liquidity and concentration concerns).

The trade-off between economic growth and environmental damage sits at the heart of unbridled capitalism. Regulation and policy have a critical role in changing the status quo. But investors and data providers also have a responsibility—starting with how ESG is measured and managed.

Bundling E, S and G factors does more than obscure facts. It’s a dangerous, deadly, distraction from the climate crisis.

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