Fifteen years ago, An inconvenient truth sent a wake-up call to the world. The documentary starred Al Gore, former US Vice President, and shed light on the climate crisis facing the planet. This had a huge effect on raising public awareness of global warming and helped spur the rise of sustainable investing, and what might be called the “ESG industry” as it exists today. .
Now, however, it’s time for proponents of sustainable investing to address some inconvenient truths of their own. The voices raised to criticize ESG – investing with environmental, social and governance standards – are credible and powerful. Acknowledging their challenge is key to finding a way forward – a way that must be found, as the climate crisis has only gotten worse since the release of Gore’s film.
The main claim from critics is that ESG rules lack rigor – and too many investments are classified as ESG without sufficient evidence.
“Most of what ESG cheerleaders wanted to believe should matter to portfolio managers didn’t actually matter,” says BlackRock alum Tariq Fancy. In an excoriating year 2021 writinghe argues that climate change requires a broad systemic response, not a financial sector-led initiative.
“Climate change is not a financial risk we need to worry about,” says Stuart Kirk, former chief investment officer at HSBC Global Asset Management, who stepped down last week. (and a respected colleague of mine at the FT). Climate change is real, he suggests, but is not a relevant consideration for investors.
“[ESG] has become a bureaucratic tax,” according to Desiree Fixler, who denounced the greenwashing of investment manager DWS, ultimately forcing the firm to reduce its ESG-denominated assets by 75%.
The reviews are plentiful – and uncomfortably close to home. Companies claim their ESG credentials too much. Asset managers make implausible judgments about which assets qualify as “green”. Financial markets are indeed short-term, and climate change is a long-term issue. There is little evidence that oil stocks, for example, are “stranded assets” that are falling in value. The financial services industry cannot solve environmental emergency or social injustice; at best, it can play a supportive role with governments.
The whole term is ambiguous. For many professional investors, ESG investing is an approach to identifying risks to a company’s financial health. Most individual consumers and retail investors, on the other hand, believe this means focusing on companies that act responsibly towards society and the environment. They are therefore often surprised to see a portfolio with low exposure to ESG risk, but which does not make a positive contribution.
To complicate matters further, professional investors typically assess a company’s ESG credentials based on a balanced scorecard across multiple factors, while retail investors tend to focus on a single issue – plastics. , fossil fuels, living wage – so reluctant to include, say, oil producer in an ESG-approved list of companies, even though it is exemplary in governance and social issues.
The credibility of the ESG approach is undermined.
But there is a way to bring rigor and responsibility to ESG, because a world in which financial profit is sought at all costs for people and the planet will not be a world in which future generations can live. In 2070, as Tariq Fancy points out, barely livable hot areas can grow from 1% of the earth’s surface today to nearly 20%, leading to mass starvation and migration. For this not to happen, everyone – governments, individuals, investors, companies – must act.
I was a financial journalist for almost 20 years, which taught me that the markets are always ahead of those who are accountable to their participants. The explosion of ESG investing has been its downfall – temporary. For decades, investment products or managers have been able to call themselves “ESG” without doing anything to prove it. It changes quickly. Regulators and policy makers have caught up.
In the UK, the Financial Conduct Authority is decide on a new sustainable classification and labeling system for investment products. In the EU, the Sustainable Finance Disclosure Regulation strengthens investor protection. The U.S. Securities and Exchange Commission has released a proposal on standardizing fund ESG information. The International Financial Reporting Standards Foundation has started work to provide the equivalent of global financial reporting standards for ESG.
It’s partly the growing stringency of reporting rules that’s driving the wave of greenwashing scandals, as watchdogs bring to light occasional abuses that previously went unnoticed and unpunished.
As regulation catches up with the market, there is still a long way to go. Many of the most relevant criticisms of ESG are that it lacks accountability and measurability. But there is already a proven approach to solving this problem: impact investing. To bring the necessary rigor to ESG investing in the future, impact investing standards must become the norm.
Impact investing is investment made with the intention of generating positive and measurable social and environmental impact alongside a financial return. Where ESG is often passive – avoiding something – impact is proactive, intentionally seeking to provide a positive benefit.
Applying this approach means that the intended impact of an investment must be taken into account and disclosed. Because this impact needs to be measured, investors can hold those who promise to deliver positive benefits, whether companies or asset managers, to account for how they deliver on their commitments. .
Impact is provided by both investors and the companies in which they invest. Investors, including retail savers, can contribute through their investment behavior – what they choose to invest in – and how they engage with beneficiary companies – shareholder engagement.
Companies can produce positive impacts. But the impact of investors and companies must be intentional and measured, to be genuine and truly responsible.
The impact investing market in the UK is already worth £58 billion, as our research in the first showed exercise to size the market. Retail investors can access the market through funds such as the Schroders Big Society Capital Social Impact Trust.
Journalists love carp. I know – I was one. But amid skepticism, it’s worth acknowledging companies that are meeting their ESG commitments. Five thousand companies in 83 countries and 156 industries are Certified B Companiesmeeting rigorous social and environmental standards.
Impact investing recognizes the shortcomings of ESG and has structured its approach to address them specifically. We know we are not there yet. But we also know that people, including individual investors, want ESG to have real meaning. To research with 6,000 of them by the UK government in 2019 showed that two-thirds wanted their money to do good for people and the planet as well as a financial return.
I believe that impact investing is the future of all investing and that ultimately all businesses will need to be accountable and held accountable for their positive and negative impacts. Solving the climate crisis is everyone’s responsibility, and if it’s not dealt with fairly, it won’t be solved. We are already almost too late to do so. If we don’t all take this responsibility, there won’t be a lot of world that none of us – or future generations – can live in.
Sarah Gordon is Managing Director of the Impact Investing Institute