In August 2022, Florida governor Ron DeSantis passed a resolution to ban fund managers from applying environmental, social and governance (ESG) factors when investing for the state’s pension funds. The move underscored a new reality for ESG investing: it is now firmly part of the culture wars.
DeSantis bemoaned ESG investments as using corporate power to “impose an ideological agenda on the American people” and accused Wall Street financial firms of employing ESG to implement policies that Florida voters had rejected at the ballot box.
The DeSantis play might seem like a parochial US political concern and far removed from the sustainable finance landscape in the UK and Europe. But it’s nonetheless significant, according to Dr Daniel Klier, CEO of sustainable data experts ESG Book and former global head of sustainable finance and group head of strategy at HSBC.
ESG investments are facing increasing scrutiny, with industry figures like Tariq Fancy, former global head of sustainable investing at BlackRock, questioning data reliability in the sector and its promise to deliver a positive environmental and social impact.
If you think about financial performance, nobody is just interested in a firm’s profit. With non-financial data we’re getting to the same point, people want to unpack what sits behind a single score
ESG is “very vulnerable” to being co-opted for the culture wars, says Klier, in part because the public doesn’t always understand what it is. “Unless we give people the tools to unpack what E, S and G actually mean you will get into these situations, with people interpreting things in a way that may not be intended,” he says.
Klier believes this situation was inevitable, as the industry has been overhyped for some time. “There is no CEO or investment officer speech that doesn’t address ESG,” he says. Now is the right time for the industry to grow up, he suggests.
“We’ve been through ESG 1.0, which was very much driven by exclusionary approaches, such as not investing in coal or fossil fuels, and a single often quite opaque ESG score,” he says. “It’s time for the next stage, where there is real transparency and integration into investment choices.”
For Klier, ESG 2.0 should deliver a nuanced discussion around what investors are trying to achieve, whether that’s a return-enhancement strategy, a risk-management strategy, or an impact strategy.
New clarity
Simon Rawson is director of corporate engagement at Share Action, a charity which promotes responsible investment. He thinks the political backlash to ESG in the US has made it a legitimate time to question what it really means and a good opportunity to ensure there is clarity and transparency in how responsible investment is being promoted.
Rawson notes the interesting parallel trend among regulators, especially in the EU, who he says are leading the way in passing laws to scrutinise green and ESG ‘washing’. “It’s helpful as it flushes out what is real responsible investment and ensures there are no new misselling scandals with asset managers and others making false claims,” he says.
For Klier, the public’s understanding of ESG would be helped by clearer labelling – a focus for the EU’s Sustainable Financial Disclosure Regulation – and adopting a more data-driven transparent approach.
“If you think about financial performance, nobody is just interested in a firm’s profit. They want to understand, ‘Is it a revenue problem? Or a cost problem? Or to do with the number of customers?’” he says. “With non-financial data we’re getting to the same point – people want to double click and double click and actually unpack what sits behind a single score.”
A more nuanced approach can help avoid a scenario where politically charged issues dominate an ESG investment portfolio. “I don’t think this debate benefits from diving into a single issue and overstressing it,” says Klier. “When we think about ESG we think about 450 metrics for every company and I think ESG, and especially S, works best if you look at it holistically.”
Some investors, particularly private investors, may be very emotional about certain topics, he notes. “Then you can build thematic strategies: for example, if they want to back companies that are led by female founders or to back companies that have a better than average diversity on the board. But it’s driven by data,” he says.
Rawson agrees: “If a business was taking a particularly extreme approach on a social issue which was arguably harmful to society, that would be a legitimate argument for stepping back, but some of those issues are better settled in democratic debate and our political system.”
Investor interest
Despite the vocal minority in the US, Rawson says data from real investors show that 95% of millennials continue to be interested in sustainable investing, while 85% of all investors continue to be interested in responsible investing, according to a Morgan Stanley study.
He believes the culture wars are a response to the increasing polarisation in society, fuelling instability and systemic risk within the investment sector, but that pandering and rejecting ESG factors as a result is not the answer.
“A vast chunk of the wealth that is invested is ultimately owned by pension savers and beneficiaries, who may even have these low-paid jobs. What’s the point of having a pension that is 10% more valuable if we’re living in a world that is inhospitable because of runaway climate change? Or in having a pension pot that is 10% bigger if you’ve worked all your life on such low pay that your health and wellbeing has suffered?”
Rawson isn’t convinced the culture war discourse around ESG will spread to the UK. “What we’ve seen from asset owners and people interested in responsible investment is that they can see through this culture war rhetoric and they know that slipping back into a system that simply prioritises financial returns at all costs is exactly the opposite of what we need at this moment,” he says.
The same debate isn’t occurring in other parts of the world, says Klier, despite the new pressures coming through inflation and high energy prices. At the same time, the US remains the fastest-moving ESG market globally. “We see the biggest demand in the US market because people have realised they’ve missed out on a very important dimension of their investment decisions over the last few years and are trying to catch up,” he says.
