ESG: The term everyone loves to hate.

Climate Economy

ESG: The term everyone loves to hate.

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The pressure is on asset managers to invest in a way judged to be green. 

When we started Climate & Capital three years ago, we knew one thing for sure: We were not going to name it after the term “ESG,” which stands for environmental, social and governance. In the investing and policy world, the word is so vague that it can be stretched and twisted into any form, Gumby-like. For academics, it is the latest iteration of socially responsible business and investing. For consultants, CEOs and boards, it’s an analytical framework for considering non-financial business factors. Investment professionals think of ESG in terms of risks and opportunities. For millions of retail investors, ESG is about green and climate investing. Think wind farms, electric vehicles and companies with environmentally and socially friendly products and services. 

That is why a growing chorus of critics argue it is simply greenwashing. 

“Our analysis shows that 80 percent of funds labeled ESG and green contain exposure to fossil fuel production and distribution,” says Elizabeth Landau, co-founder of GreenPortfolio, whose proprietary black box analyzes the climate-friendliness of financial institutions. Climate skeptic Ken Pucker points out that the top holdings of the S&P 500 ESG index include Exxon, fossil-fuel lender J.P. Morgan Chase, and looks surprisingly like the standard S&P 500 index. The difference is that S&P 500 index funds can be bought for as little as 3 cents to a dollar, while an ESG fund can quadruple that number. 

This is a big reason that ESG is at the center of divisive American politics, a criminal investigation of one of Germany’s leading asset managers, and a source of endless debate on LinkedIn and at investment conferences. To many, ESG is a critical path forward to solving vexing issues confronting large global organizations. To others, it is the intellectual Pet Rock of our era. The Economist calls ESG a broken system in need of urgent repair. Harsh but not surprising.

That is one element of ESG that almost everyone will agree is true. Almost everyone will also agree that ESG has been a cash cow for giant global asset managers where there are more than $7 trillion in ESG investment funds in fee-generating asset management under management. That is 10 percent of all the world’s fund assets. A decade ago, ESG did not even exist. Even today, with global credit markets frozen and investment being curtailed, ESG-like investing in everything from power grids to data continues to grow.

One size fits all 

Its fact is all of that and so much more, which is why it has become the epicenter of a raging debate on whether ESG is helping create a more just, sustainable and climate-friendly world or the latest investing and corporate strategy fad.

“ESG has nothing to do with morality, ethics or politics […] Read the literature.” And herein lies the problem. No one reads the literature. ESG is really anything you want it to be.

ESG is a noble idea with noble roots. The term is said to have originated from a report developed by Paul Watchman, a special advisor to the UNEP and lawyer at the UK law firm Freshfields. Watchman says ESG’s original intent is a means of “assessing risk and opportunity for investment decision-making and the potential impacts of investments on the environment and communities.” He is quick to point out that ”ESG has nothing to do with morality, ethics or politics […] Read the literature.”

From natural to ESG 

And herein lies the problem. No one reads the literature. ESG is really anything you want it to be.

The term is a marketer’s dream. It is similar to the term “natural” that was highly popular with consumer product marketers in the early 1970s who, taking advantage of the first environmental craze in the U.S and Europe, used “natural” as a label for everything from cereal to shampoo. Like ESG, there were no consumer protection laws, so it could be used to sell anything, whether it truly had any environmental benefit or not.

Fast forward to 2015. 

The world suffered through the Great Financial Crisis of 2008-09. Trust in companies and banks was at an all-time low. Occupy Wall Street was in full swing, and public awareness was rising over the dangers of climate change. Along came a strategy that addressed all of society’s ills. 

ESG soon became the “it” investment strategy of the decade. 

The party is over 

The problem with ESG is it has been a lexicon catch-all that can make any company look good. ESG is a framework of all carrots but no sticks. What CEO, what board, what climate NGO or well-funded academic would disagree with this one-size-fits-all label of responsible corporate citizenship? Companies can have their cake of corporate goodwill and business-as-usual prosperity.

ESG results are not surprising. The Economist concludes that ESG “has had a negligible impact on carbon emissions, especially by the biggest polluters. Its attempt to address social issues such as workplace diversity is hard to measure. As for governance, the ESG industry does a lousy job of holding itself to account, let alone the companies it is supposed to be stewarding.”

The greenwashing of America

There is also a dawning realization that in the short term, at least, ESG will not be able to demonstrate any quantifiable improvement in a company’s business. It is no surprise then that on Wall Street, management consultants are sharpening their pencils and quietly advising companies to rethink all those new sustainability hires as the end of cheap credit begins to trickle down to the bottom line. 

The problem with ESG is it has been a lexicon catch-all that can make any company look good.

But on a deeper societal level, there is a growing realization that every element of ESG has deteriorated since the term first came into vogue. You don’t need esoteric ESG metrics to understand that every ESG signal is flashing a bright red. 

Environmental and climate risks are more than obvious as extreme weather events wreak continuous havoc around the world. Fossilized global governance bodies like the UN, the polarized political bodies of democracy and an increasingly confused corporate culture are struggling to quantify the reality of ESG with the dream of ESG. “ESG is past its sell-by date,” says sustainability expert Robert Eccles.

Worse, it remains a powerful greenwashing tool. How much more cynical can it get when the world’s largest plastic polluter – Coca-Cola – is the official sponsor of the UN’s COP 27 climate talks? 

“We are operating a paradigm that is suboptimal,” says Kathryn Judge, Vice Dean of Intellectual Life at a Columbia Law School conference. “Patterns are emerging, and we are beginning to understand the need to make the pivot.”

But we do know that those who fight for what is meaningful in their lives, for local solutions that make sense, their family and their community, will have a far better chance of survival in the sharp glare of the future than those fearful, lost souls cowering in the black shadows of Plato’s cave. The winners will be those who are part of a movement, not passive bystanders. 

As Kermit the Frog from The Muppets says, “it’s not easy being green.” With ESG, it can be difficult to decipher fact from fiction, which suits nearly everyone just fine.

Written by

Peter McKillop

Peter McKillop is the founder of Climate & Capital Media, a mission-driven information platform exploring the business and finance of climate change.