The sustainable finance industry is facing a growing battle on two fronts as Republican lawmakers ramp up a culture war against “woke capitalism” and investors demand more decisive action on climate change.
The squeeze is causing the environmental, social and governance (ESG) industry to push back against conservative attacks by asserting that its only goal is to protect investors from social and environmental risk.
But some industry leaders say the conflict demands a new approach based on real-world impact – particularly on CO2 reductions – and away from the sole reliance on environmental and social risk.
In August, Texas banned 10 asset managers and about 350 investment funds from doing business with the state, including management of US$300 billion in public pension funds, for supposedly “boycotting” oil and gas companies from their portfolios.
Recently, Republicans have focused their attacks on BlackRock, the largest asset manager in the world and a high-profile proponent of ESG investing. Nineteen Republican-led states accused the company of ignoring investor needs by supporting climate commitments that “force the phase-out of fossil fuels, increase energy prices, drive inflation, and weaken the national security of the United States.”
BlackRock is scrambling to push back against the attacks, insisting it’s simply working to manage the risks of the energy and climate transition. ESG industry analysts have joined BlackRock in condemning the attacks. “These efforts are an attempt to gin up another phony grievance about how ‘liberal elites’ are destroying the country,” says Morningstar ESG analyst Jon Hale, adding it’s laughable to think of Wall Street money managers as left-wing ideological warriors.
Former U.S. vice-president Mike Pence helped kick off the conservative backlash when he declared in May that “the woke left is poised to conquer corporate America and has set in motion a strategy to enforce their radical environmental and social agenda.”
Republican denunciations of sustainable investing are an absurd caricature of the industry, but they have helped to expose the confusion and lack of standardization in ESG assessments, making the industry and the money managers that rely on them vulnerable to attacks from both climate-concerned investors and business-as-usual conservatives.
Take BlackRock, for instance. The company is a strong proponent of “stakeholder capitalism” and is a prominent member of the Net Zero Asset Managers (NZAM) initiative, a global network pledging signatories to reduce financed emissions to net-zero by 2050. But these declarations contrast greatly with BlackRock’s record.
The company holds more than US$300 billion in fossil fuel investments, including more than $100 billion in Texas companies. In its NZAM disclosures, BlackRock says it expects its portfolio companies to evolve toward net-zero, which means that it doesn’t need to divest its fossil fuel investments. It has also said it plans to vote for fewer climate-related shareholder resolutions in coming years as investors ask for increasingly detailed and demanding greenhouse gas commitments from their investee companies.
These efforts are an attempt to gin up another phony grievance about how ‘liberal elites’ are destroying the country.
-Jon Hale, ESG analyst at Morningstar
But BlackRock isn’t the only financial company with an ESG reputation problem. Banks, investment managers and asset owners all rely on the global system of ESG ratings, which has faced growing criticism.
In addition to confusion in ESG assessments, a recent Bloomberg investigation found that rating agencies like MSCI focus more on a checklist of corporate policies rather than actual company impacts. It cited the example of McDonald’s, which received a rating upgrade after improving some environmental policies despite the fact the company’s massive beef purchases produce more greenhouse gas emissions than the country of Portugal.
This is prompting some industry leaders to call for reform.
“That checklist is a blunt instrument that doesn’t reflect the challenges, subtleties and trade-offs of ESG,” says David Blood, who co-founded Generation Investment Management with former U.S. vice-president Al Gore. “People say sustainability or ESG is always a win-win – of course it isn’t. There are trade-offs.”
This question of trade-offs is becoming increasingly important. The energy crisis triggered by the Ukraine war is forcing some asset managers to sacrifice CO2 reductions needed in the next decade for growing fossil fuel profits. This goes against traditional sustainable finance belief that there’s no conflict between financial return and ESG performance.
“Investors increasingly want both sides of ESG: to mitigate risk and to make a difference in the world,” says Morningstar CEO Kunal Kapoor. “These are not the same, and they come with a new set of trade-offs for investors to make.”
The current situation is causing ESG rating agencies to add impact metrics to their product listings, in part to meet new European Union sustainable fund classifications. And while many small investment managers have specialized in ESG impact for years, giant asset manager JPMorgan recently announced a new “double materiality” product, incorporating present risk and future impact.
The UN-backed Race to Zero initiative also has the potential to drive real-world impact. Earlier this year, Race to Zero mandated that all entities pledging to achieve net-zero by 2050 under UN rules will need to avoid new fossil fuel investments, starting within 12 months. This includes banks, insurers, asset managers and asset owners that are members of the US$130-trillion Glasgow Financial Alliance for Net Zero.
This is expected to put enormous pressure on companies like BlackRock and the world’s largest banks and asset managers to reject new oil, gas and coal investments, setting the stage for even more conflict with Republican lawmakers.
But this may be a necessary consequence of needed ESG industry reform. If the sector can evolve toward a model of transparent, real-world corporate assessment, rather than relying solely on the notion of present-day risk, it will be better equipped to withstand the clash from conservative and sustainability critics.
Eugene Ellmen is a former executive director of the Canadian Social Investment Organization (now Responsible Investment Association). He writes on sustainable business and finance.