Skepticism in ESG’s ability to make an impact (ex-BlackRock essay summary)
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Issue #92: A weekly update on responsible investment.
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In August, BlackRock’s former Head of Sustainable Investment, Tariq Fancy shared his doubts on the world of sustainable investment. I decided to dive into his full 40-page essay on the topic (link to the full essay on Dropbox here) and provide a summary for you all, subscribers. He has a lot to share on the topic and I’ve tried my best to make the summary bite-sized enough for those of you who do not have the time to read the entire piece. My TL:DR, He is worried ESG / any market-led solution is a distraction and we need much bigger government / policy change to solve the major problems we face.
What drew him in: The essay starts by him sharing his initial hopes / dreams when he learned about ESG. He shared the core premise of ESG: “in addition to getting a solid market return on your investments, your investment also makes the world a better place. This promise is what lured me to join BlackRock to begin with.” He also shared about getting to know Larry Fink who believed “BlackRock was uniquely positioned to lead the world in the direction of a more sustainable version of capitalism.”
Initially, he still had hope on sustainable finance: “I sincerely believed that while sustainable investing was not perfect, it was a step in the right direction in the critical question of how business and society should intersect in the 21st century.”
Now, he is a skeptic: “I now realize that I was wrong. If the COVID-19 pandemic has taught us one key lesson, it’s that we must listen to the scientific experts and address a systemic crisis with systemic solutions. Reacting instead with denial, loose half-measures, or overly rosy forecasts lulls us into a false sense of security, eventually prolonging and worsening the crisis. And yet Wall Street is doing just that to us today with the far more dangerous threat posed by climate change, craftily greenwashing the economic system and delaying overdue systemic solutions, including those intended to combat rising inequality and the insidious political risks it creates.”
Basketball, sustainability and the externalities that affect us all: “Much of what people talk about in regard to making capitalism sustainable is related to what economists call externalities: side effects of specific business activities that affect all of us… In the basketball example, a negative externality might be when one of the players jumps into the crowd to retrieve a loose ball and ends up seriously injuring a few fans. In our economy, pollution is an example of a negative externality: an undesirable side effect from an industrial process for private profit that we, the broader public, did not choose to incur, but for which we collectively bear the consequences.”
Members of corporate board rooms ultimately make their decisions based off of what all of us, individual investors, want. “BlackRock can’t just do whatever it wants with everyone’s savings. We, the owners, trust them, the agents, to control and supervise our property, and as such, they legally owe us what’s called a fiduciary duty to act in our best interests.”
Larry Fink’s annual letter: He went on to summarise the now infamous annual letters of Larry Fink further emphasis how BlackRock hopes to double down on sustainability.
The problem with divestment: “Divestment, which often seems to get confused with boycotts, has no clear real-world impact since 10% of the market not buying your stock is not the same as 10% of your customers not buying your product. (The first likely makes no difference at all since others will happily own it and will bid it up to fair value in the process, whereas the second always matters, especially for a company with slim profit margins and high fixed costs.)”
Are ESG academics incentivised to find ‘something?’ “Since you generally can’t publish a “null” in academia — a conclusion that there’s no real connection between causes and effects being studied — this meant more researchers with an incentive to find something, meaning for the most part highlighting specific, small ways that ESG may be good for long-term profits.” With this he brings to question if ESG truly helps performance and also discusses the big issue of ESG rating agency divergence.
Performance determines compensation, if ESG was truly useful investors would use it naturally: “Whether structured or unstructured, you could call [ESG] another data set.” Investors would use it as another data set if they thought it could help them get above average returns.
The purpose of a business: Public companies purpose is to serve their shareholders. If business is serving shareholders, would all acts of corporate purpose primarily serve as marketing stunts?
His decision to leave BlackRock. “Officially, my reason for leaving was due to very real family business issues I had to help with following my father-in-law’s passing. Unofficially, I had also privately concluded that there was no point continuing in that role: trying to create real-world social impact through sustainable investing felt like pushing on a string.” “In my role at BlackRock, I was helping to popularise an idea that the answer to a sustainable future runs through ESG and sustainability and green products, or in other words, that the answer to the market’s failure to serve the long-term public interest is, of course, more market.”
Covid-19 government reaction comparison to emissions: He compares the different responses and restrictions governments placed on citizens and the impact those regulations had on people’s health. Bringing this back to ESG he shares: “If voluntary and individual measures are clearly not good enough to bend our society’s COVID-19 infections curve downward, then why do the experts think that such measures will bend our society’s greenhouse gas emissions curve downward?”
Don’t leave key ESG issues to the individual, it needs to start with government. A core argument of the essay. Voluntary commitments and non-binding words by corporations is not enough for the problems we face, there needs to be government action.
Weeks versus Decades — the difference between COVID-19 and Climate Change: “There’s an important difference between COVID-19 and climate change. You find out that you’re infected by COVID-19 within a week or two of exposure; by contrast the worst consequences of the slow-moving accumulation of greenhouse gases in the atmosphere will arrive decades after we belch it out. The slower incubation period allows us to indulge in the fantasy that voluntary and individual action alone will somehow aggregate into the systemic change we desperately need right now.”
Is sustainable investment a distraction? Protecting an investment portfolio from the disastrous effects of climate change != Preventing those disastrous effects from occurring in the first place.
Why he wrote the essay: “The goal of this essay is to clearly communicate the dire need for urgent government action to address systemic problems, not to spell out the specific policies any government must enact: there’s no shortage of expert policy ideas to address these problems, and most will vary in the details from country to country.” “It’s time to accept that there are nine words that we need to hear, because we can only build a sustainable future once we’re no longer terrified to hear them.
I’m from the government and I’m here to help.”
Reactions to the essay: I’ve seen a ton of follow-up / replies to this essay since it was published which I’ll link here (Pro his article: Robert Armstrong, Financial Times, Neutral his article: Moral Money, Financial Times, The Economist) For me, I appreciate a lot of his points and many are topics that I’ve already heard most critical minds working within the ESG industry discuss. Overall, I find the essay overly negative but the point that I think should be translated to all professionals within ESG is we should be skeptical of ESG as a “Too good to be true” solution. We need to consider it’s strengths (considering risks outside of traditional financial analysis of companies) and it’s weaknesses (lack of standards, hard to compare companies, greenwashing) and collectively work to improve what is still an emerging industry. On top of this, I agree that governments are very key stakeholders in the world of ESG as is the public who puts pressure on where they purchase from. For our role as ESG professionals, we need to consider how we can help empower / work collectively with each of these groups to help them succeed as well.
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ESG Nutrients
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How Venture Capital Can Join the ESG Revolution
Venture capital has largely been left behind in the massive rise of ESG integration in investment management. Looking at the websites of the top 50 largest venture capital funds, only found five which mentioned ESG or a commitment to sustainability, while only a few dozen more firms have made public commitments to ESG (among the more than 2,900 VC firms worldwide). A recent study found that almost none of the world’s largest VC funds consider human rights in their investment process. Only one ESG topic, diversity, and inclusion, has seen widespread focus among VCs so far.
SSIR.
Achieving Low Carbon Portfolios the Quantitative Way
Carbon intensity is defined as the amount of carbon emissions caused by a company (metric tons of CO2) divided by its revenue (in USD millions). This figure measures the amount of greenhouse gas that a company emits relative to the sales it generates from these emissions.
Does All ESG Money Really Go Toward Sustainability Issues?
According to Global Sustainable Investment Alliance’s (GSIA) latest report, sustainable investment assets expanded to $35.3 trillion globally last year, or $1 of every $3 in globally managed money, amid growing concerns over societal inequities and climate change. GSIA added that the lion’s share of the money, or about $25 trillion, is invested in strategies called “ESG integration” or “ESG consideration.” While these ESG integration strategies allow managers to include ESG data in financial models, money managers may actually only be “aware of” and “take into account” ESG factors when making their investment decisions. Essentially, these managers may not actually be forced to act on ESG input data and only look at them as considerations.
Nasdaq.
French Companies Lead Europe On Incorporating ESG Metrics in CEO Pay Plans
France leads Europe with the highest number of companies (an expected 71 percent) incorporating ESG metrics into executive pay plans this year. Additionally, the UK has had a noteworthy rise in ESG metrics in executive compensation plans for CEOs from 8 percent in 2008 to a predicted 54 percent in 2021. The energy (66 percent) and utilities (61 percent) sectors are expected to have the highest percentage of companies with ESG key performance indicators in pay for CEOs. The healthcare sector will have the lowest, with only 25 percent.
IR Magazine.
GRESB ESG Benchmarks Expand in 2021 Despite Covid [Real Estate]
Participation in GRESB 2021 assessments grew by 26% over 2020 to 2,227 real estate and infrastructure entities, surpassing expectations amid the global Covid-19 pandemic. While global real estate participation increased by 24% this year, there were notable regional increases:
- Italian market coverage grew the most, both in terms of absolute and relative increases, with more than 50 new entities participating (a 329% increase from last year)
- German market coverage increased by 68%, with more than 30 new entities participating
- US market has now reached 300 participating entities
- Japanese and Australian markets have both reached over 100 participating entities.
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Reliance on ESG Data Providers: Better as “Opinions” than “Ratings”? Parts 1 & 2
Differences in methodologies and data sourcing have caused widely discussed differences in ratings between providers and the correlations between ESG data providers can be very low. In an often-cited paper, these correlations average around 0.60 which is significantly lower than the correlations between credit rating agencies, such as Moody’s and S&P, which tend to remain close to 0.99.
Where are divergences identified?
- definitions of materiality,
- normalisation techniques,
- aggregation and weighting,
- survivorship bias and missing data,
- use of standards and metrics,
- creation of benchmarking and peer groups,
- sources and timing of data collection, and
- conduct vs product-based scoring methodologies.
Companies get hurt for lack of disclosure:
- Example 1: Strong Policy, Poor Disclosure = Poor Rating. If a company has a best practice diversity & inclusion, employee health and safety, or other type of ESG policy, but does not make the policy publicly available, certain ESG ratings providers will give that company a low rating (or the industry average).
- Example 2: Comprehensive policy, poor follow through = Higher Rating. Companies that publish well written, comprehensive policies receive higher ratings even though these policies may not be followed at an operational level. Simply having a policy for an ESG issue does not mean the issue is being properly managed at a company
Regional biases:
Developed versus developing world: The materiality of an ESG issue can vary depending on the country or the region of the firm. For instance, while issues such as “worker health and safety” are very important in developed markets, developing markets may favor job creation over health and safety to reduce poverty levels. This may create rating biases in favor of firms in developing countries (unless normalized for regional differences), since most ESG rating agencies tend to be from Western countries.
Large Caps: Biases in ESG company scores may push investment portfolios toward larger cap companies and regions with higher levels of regulatory reporting for sustainability issues. This does not necessarily mean that these are the most sustainable companies in the investment universe.
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