The ESG Advocate 004 - On the attack!
Like anything, ESG can be warped and manipulated into a scapegoat. When used properly to identify issues, it improves a business's standing, reduces risk, and drives action. On the other hand, it can be used as a marketing shield against action (greenwashing) or as a political talking point.
ESG is wildly complex beyond the simple 3-letter acronym and is constantly being squeezed in a world where black-and-white talking points rule discourse.
This week was no different, let's get to it!
Stuck in the middle with ESG
Politics and activism are pushing and pulling ESG in the middle of their particular objectives. It looks like this.
Right-wing pundits pushing left-wing conspiracy agenda
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ESG
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Climate activists thinking ESG is a distraction from climate action
For right-wing pundits, ESG represents a value attack. The American First Policy Institute wrote a thoughtful criticism of proxy advisors and ESG, surrounded by a baffling conclusion about politics and liberal value alignment with ESG. The reality is the UN Global Compact, and some of the largest financial services firms in the world created ESG (see page 3 of "Who Cares Wins" here), or better yet, listen to Elizabeth Pollman of UPenn talk about its origins here.
Today's corporate value exists mainly in intangibles, and many unaccounted risks lie in externalities. Looking at an investment without ESG is like trying to take in the sky by looking at it through a cardboard tube. Here's a graphic with a highly generic person, Mark Spence, checking his investments.
When governments take an approach that discounts ESG issues, as Texas did with big banks considering ESG, citizens can feel the consequences. Per this article:
In their study, the co-authors analyzed data from the first eight months of the law and estimated that Texas cities will pay an additional $303 million to $532 million in interest on $32 billion in bonds.
On the climate activist side, we have this concise piece with a triggering title, "Europe Falls For ESG And Its Idiocracy," proclaiming that ESG goes against nature's principles. Again, very valid criticisms of ESG in the three points, but the hard pivot to "ESG is idiocracy" rather than "let's call out greenwashing" is a little too harsh. There can be intersections between ESG and sustainability, like putting climate advocates on Exxon Mobil's board or pushing the homebuilding industry to set better goals for sustainable lumber sourcing.
Another point to consider is that ESG puts a company and its leaders at the center of the climate story. This is Storytelling 101 and a way to get people to drive action!
On the Climate 21 podcast, award-winning journalist Dan McDougall describes how he uses storytelling to showcase climate issues and the emotions he tries to pull out to drive understanding. While he doesn't talk about ESG and isn't targeting corporate audiences for actions, the methodology is transferrable.
If we want ESG not to be a distraction, we need to put corporates at the story's center and show them their risks and impact. In the same podcast, host Tom Raftery calls out the power of bringing these stories 'local.' Again, this is what ESG does. Getting them to own the issue and make the hard change is a shorter leap.
Combine the power of putting the target at the center of the climate story with the fact that brands sit on top of the trust pyramid right now, and you have a powerful engine to create change.
ESG Reality Check Cheat Sheet - by Cary S. Krosinsky
Enter Cary Krosinsky's latest piece to bring us some clarity. ESG is a lot of things, and Krosinsky gives us a little comfort in this uncertainty while calling out the valid criticisms surrounding practitioners, greenwashers, and data providers.
A couple of things stood out to me. First, ESG represents issues, not some abstract value-signaling, despite both sides' calls above. This concept seems to be what people struggle to understand the most because these issues are complex and not black-and-white. If you switch a high-carbon supplier in a rural area out for another one, how did you impact their local economy, for example?
Besides the issues, ESG data is complex. Quantitative standards and data may never show the complete picture. I believe data can be proof of a company's story, but it isn't irrefutable and ironclad, depending on activities, externalities, and other factors.
Lastly, will ESG survive this onslaught and confusion? Of course, it will because, to the first point, ESG represents issues.
Businesses will always struggle with issues.
The outflows will continue until ESG improves
ESG funds losing their luster, or just reacting to the economy? — esgclarity.com
With so many interpretations of what ESG is and isn't, we have a mess of mislabeled funds, greenwashing, and what appears to be a market pullback from ESG funds.
Is this really happening, or are ESG funds just matching the market? That seems to be the argument made by this strange op-ed in the WSJ. The author attempt to have it both ways, ESG matches the market, and ESG funds are down. You can't have it both ways, so we're left to conclude that:
ESG funds match market funds (albeit with higher fees) <- can be true sometimes
ESG funds are down, and the market is down.
Therefore, don't invest in the market! 🤣
But I digress to this article over on ESG Clarity, which takes a more unbiased analysis of the outflows: "One can draw from this that ESG funds aren't immune to the global economic shock that continues to reverberate and send waves through major economies and investor sentiment."
I think this leaves an essential question on the table:
Is good ESG risk management a leading indicator of short-term alpha?
This would seem to be the antithesis of ESG. Indeed, it can't be bad for ESG funds that are engaging investments and attempting to understand best how risks are mitigated, and new opportunities are created? I suspect companies who understand ESG will weather this market downturn and survive over their competitors in the long term, but patience is not built into our current market system.
Tweet of the Week
If you search for ESG tweets this week, you'll likely come across articles like the one below, covering the impact of ESG and stakeholder pressure on the political uprising in Sri Lanka.
Shellenberger's write-up is one of the more thoughtful ones, covering the complexity of the issues in Sri Lanka over the past four years: crushing government debt and over-ambitious plans that couldn't have predicted two crises: COVID and Russia's invasion of Ukraine.
In articles like these, we are told that ESG is to blame. In 2021, the government cut access to chemical-based fertilizers to farmers, leading to massive farming losses. While this was undoubtedly a contributor, I encourage anyone interested in this topic to listen here to learn more about the various factors that have been building up.
The Daily: How Sri Lanka's Economy Collapsed (around 6:30)
This is less about ESG and more about traditional financial mismanagement, inequities (social), and corruption/bad policies (governance). When Shellenberger asks, "Why did they engage in such a radical experiment?" I think the answer is simple. The government was in dire financial straits and didn't know what to do.
As a result, the fertilizer ban certainly played a role in the collapse but was only the trigger, not the bomb. To hear about this specifically:
Today in Focus: What's behind the economic implosion in Sri Lanka (around 16:00)
Why was fertilizer banned? While the President discussed this at a forum on the 'green' economy, as noted in this article, the real culprit would seem to be misguided fiscal policy:
Sri Lanka has said chemical fertilizer will be banned to save 400 million dollars in foreign exchange spent on imports and about 50 billion rupees of fertilizer subsidies will be saved, which can be re-directed to farmers as subsidies.
There are a few problems with this. Sri Lanka had "a 13.9 percent fiscal deficit by this point." Besides this not playing out as the President had thought, the real issue is that no one educated the farmers on organically farming, which led to massive losses.
When asked if ESG caused the uprising or the economic collapse, Anushka Wijesinha, co-founder of the Colombo think-tank Centre for a Smart Future, said this in a Financial Times article:
To attribute the economic crisis to ESG is not just a stretch but quite a flimsy argument by these folks.
So, upon closer inspection, it looks like we have two truths:
Several factors contributed to the economic instability for Sri Lanka and across the population, leading to the uprising
The fertilizer ban happened way too fast without broader consideration of the farmers' ability to pivot to organic farming or support their livelihoods
Sri Lanka can serve as a cautionary tale on how the speed of acting on climate change needs to consider broader transition risks, which is fundamentally ESG. The pressure to advance is great, but we can't forgo critical thinking about issues to hit a metric.
The Netherlands is similarly struggling, but differently. The government didn't execute an immediate and careless carbon reduction plan. Instead, it has targets out at 2030. Again, the government didn't create a transition plan for farmers, leading to massive protests. Instead, the approach appears to have been "We committed to environmental goals. Provinces, go figure this out," instead of engaging with education, subsidies, and science.
Side note: With the US Supreme Court pushing more and more rules to the states, I could see a similar situation brewing.
Governments will play a critical role in change, but we can't move too fast and be careless in our approach, even with distant goals. Public engagement, financial assistance, and even systemic changes will be needed. It is important to note that there is no other choice, as farmers in northern Italy are learning. Instead of policy change, climate change is hitting the farmers. One way or another, this issue is coming to a head.
As ESG practitioners, governments, and company leaders drive towards much-needed change, we must remember that every action has consequences.