The rise and fall of ESG investing

First word

I REGULARLY monitor national and international media for the latest news and developments in the climate debate and the much-ballyhooed energy transition.

Two articles at the end of 2022 stand out for their crushing reports on the evident downfall of environmental, social and governance (ESG) investing.

ESG investing, in the Investopedia’s definition, refers to a set of standards for a company’s behavior used by socially conscious investors to screen potential investments.

Environmental criteria consider how a company safeguards the environment, including corporate policies addressing climate change, for example. Social criteria examine how it manages relationships with employees, suppliers, customers and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.

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According to these two articles — “The year ESG fell to earth” by Rupert Darwall in the RealClearEnergy website (Dec. 27, 2022); and “The great anti-ESG backlash” by Oliver Wiseman in the Spectator (January 2023) — ESG will have little to expect in the new year. Its opponents will have a better year. I reprint excerpts here from both articles.

The year ESG fell to earth

From Rupert Darwall in RealClearEnergy:

“The year 2022 brings an end to an era of illusions: a year that saw the end of the post-Cold War era and the return of geopolitics; the first energy crisis of the enforced energy transition to net zero; and the year that brought environmental, social and governance (ESG) investing down to earth with a thump.

“For the year to date, BlackRock’s ESG Screened S&P 500 ETF lost 22.2 percent of its value, and the S&P 500 Energy Sector Index rose 54 percent. The three are linked. By restricting investment in production of oil and gas by Western producers, ESG increases the market power of non-Western producers, thereby enabling Putin’s weaponization of energy supplies. Net zero — the holy grail of ESG — has turned out to be Russia’s most potent ally.

“It wasn’t only a bad year for ESG on the stock market. Earlier this month, Vanguard announced that it was quitting Glasgow Financial Alliance for Net Zero (NZAM), set up by former governor of the Bank of England Mark Carney a little over a year ago. ‘We have decided to withdraw from NZAM so that we can provide the clarity our investors desire about the role of index funds and about how we think about material risks, including climate-related risks,’ the world’s second-largest asset manager said.”

Two months ago, Alex Edmans, co-author of the latest edition of the standard textbook on the principles of corporate finance and professor of finance at the London Business School, published a paper titled “The End of ESG” — without a question mark.

October also saw the publication of Terrence Keeley’s Sustainable, where the former BlackRock senior executive penned what amounts to a requiem for ESG. Rather than “doing well by doing good,” the logic of Keeley’s case, as I reviewed for RealClear Books, is that investors in conventional ESG investment products are likely to end up not doing very well.

It has not all been going one way. In May, HSBC terminated Stuart Kirk, its global head of research at HSBC’s asset-management arm, for voicing some hard truths about ESG. Earlier this month, HSBC announced that it will stop financing new oil and gas fields, putting the West’s third-largest bank on Putin’s side in Russia’s energy war on the West.

What is now a negative factor disadvantaging the West in a world increasingly characterized by East-West geopolitical tensions originated after a period when the United Nations had been fostering a horizontal global division between a rich North and an exploited South. As University of Pennsylvania’s professor Elizabeth Pollman records in her June 2022 paper “The Origins and Consequences of the ESG Moniker,” through the 1970s and early 1980s, the UN promoted the new international economic order that called for the regulation of transnational corporations on the alleged grounds that they were widening the gap between developed and developing countries.

ESG means different things, depending on whom you’re talking to. Is it about risk disclosure? Or about factors driving long-term shareholder value? Or is it about society holding business to account? One thing is clear: ESG’s unsustainable dual mandate of boosting shareholder returns and at the same time making the world a better place — “doing well by doing good” — was present at the creation of ESG. It was a masterstroke by ESG’s designers to incorporate “G” for governance. No investor can be against improved governance, and it helped mainstream ESG, whereas previous iterations, such as socially responsible investing (SRI), remained niche.

The 2008 financial crisis subsequently turbocharged the uptake of ESG. Having caused the financial crisis, Wall Street was going to redeem itself by saving the world from a planetary catastrophe. Without climate change, ESG would have vastly less salience. Although marketed as a climate risk analysis tool, ESG is no such thing. In reality, it’s about investors and debt providers driving the decarbonization of Western companies and sun-setting its oil and gas companies.

According to ESG doctrine, there are two types of climate financial risk — physical risk and transition risk — and it’s straightforward to demonstrate that both are spurious…

In its sixth assessment report, the IPCC (Intergovernmental Panel on Climate Change) declared that with sustained warming, there was limited evidence that the Greenland and West Antarctic ice sheets would disappear “over multiple millennia.” That is some time horizon. Despite the best efforts of central bankers, geologic timescales of millennia and human timescales of decades are completely out of whack.

Similarly, climate transition risk and the stranded assets trope defy economic and financial logic. If you restrict the flow of capital into a sector producing stuff that people want and are willing to pay for, the price of the output of a capital-embargoed sector will rise, as will the value of its invested capital… In the absence of draconian government policies to suppress demand for oil and natural gas, ESG policies strangling the supply of capital to Western oil and gas producers have two effects: they push up the price of hydrocarbons; and they displace supply from Western producers to neutral or hostile ones, with major detriment to the economies and security interests of the West.

The backlash

From the Spectator, “The great anti-ESG backlash”:

“The ESG story starts in 2004, when the three-letter acronym appeared in a UN report arguing for environmental, social and governance considerations to be hardwired into financial systems. Since then, the term has been on a long but rapidly accelerating journey from NGO-world obscurity into the financial mainstream and subsequently the political limelight, prompting strong reactions from a chorus of prominent figures. Elon Musk calls it ‘a scam.’ Peter Thiel says it’s a ‘hate factory.’ Warren Buffett describes it as ‘asinine.’

“Unsurprisingly for a piece of UN jargon that has become part of the political cut and thrust, ‘ESG’ is often used to mean different things. Properly defined, it refers to an investment strategy that factors in environmental, social and corporate governance considerations.

“As it has grown in infamy, the acronym has also come to refer not only to investment products billed as ESG, but to other practices through which investment firms use their customers’ money to push political ends…

“Some of ESG’s biggest proponents have embraced a similarly broad-brush frame. Thanks to his remorseless embrace of right-on buzzwords and jargon like ‘stakeholder capitalism,’ Larry Fink is the financial titan most associated with ESG. As chief executive officer of BlackRock, the world’s largest asset manager, Fink never misses an opportunity to point out the happy coincidence that investing with his firm will not only make you rich, but save the world.”

This win-win rhetoric has been the rallying cry of the ESG crowd on what has looked like an unstoppable march…

ESG first came across Riley Moore’s desk soon after he was sworn in as the state treasurer of West Virginia in January 2021. As he explains, energy companies operating in the coal- and gas-rich Mountain State complained to him of the difficulties they were having accessing capital, thanks to the big banks’ ESG lending policies.

Access to capital is a very real problem for energy firms these days. According to Goldman Sachs, the cost of capital is 15 percentage points higher in high-carbon versus low-carbon energy products today.

It occurred to Moore that US states are big customers of the same financial institutions that the businesses which provide high-paying blue-collar jobs in West Virginia were struggling to borrow from. Why should we do business with firms that seem determined to hobble our state’s economy, Moore wondered — first to himself, then anyone who would listen.

“We looked at all the banks and asset managers my office was doing business with, and a good number of them had prohibitive lending policies to the fossil fuel industry,” he explains. Moore’s response did not rely on the passage of onerous regulation. It simply involved the state of West Virginia exercising its right to do business with whomever it chooses. Last January, Moore responded to BlackRock’s call for companies to embrace net zero by dropping the asset manager’s funds from West Virginia’s investment portfolio.

Other states have followed West Virginia’s lead. In October, Louisiana pulled nearly $800 million of funds out of BlackRock. Missouri and South Carolina have done the same. In total, at least a dozen Republican state treasurers have been involved in a pushback against ESG in some form.

While treasurers are flexing their state’s financial muscles, attorneys general have been using their legal authority to push back. In August, 19 state attorneys general wrote to Larry Fink, warning that BlackRock “appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment, as well as their vote.”

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