25 August 2021

ESG has become a ‘dangerous placebo’ – it’s time to shut it down

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‘Environmental, Social, and Governance’ (ESG) is a marvellous concept, appallingly executed.

The fundamental problem with ESG is how markets actually operate. Even after decades in finance, I’m still amazed at just how inefficient markets can be, how distortions are often ignored, groupthink dominates strategies, and sheer laziness leads to all kinds of tomfoolery.

Markets are about the madness and behaviour of crowds. It’s very different to what I was taught back in the early 1980s when economists wittered on about ‘rational expectations’. I’ve learnt there is nothing particularly rational about the way market participants tend to think.

Several distortion themes have mainly dominated markets over the last few years. The first is monetary distortion, which has utterly dislocated the pricing mechanism of markets. The second is ESG–based investing, which has become like the Spanish Inquisition in its determination to root out and punish unbelievers and burn them as heretics.

ESG has become a particularly dangerous notion. Although I believe in the science of climate change, am probably the last Clause Four Socialist left working in the City and will only invest in companies that can show pristine corporate governance, I find ESG to be a very poorly constructed edifice. I’ve long believed many ESG proponents have been feathering their own nests.

I’m not the only person who sees it. This week we’ve seen an incredible post by Tariq Fancy, entitled the Secret Diary of a ‘Sustainable Investor’. He’s the former head of Sustainable Investing at Blackrock, which boss Larry Fink has committed to ESG goals. Fancy resigned when he figured out ESG was riddled with inconsistencies, dubious motivations and concluded it was ‘a dangerous placebo that harms the public interest’. Fancy has called ESG ‘marketing hype’ and ‘a dishonest promise’. He has identified many issues, including that financial institutions have obvious motivations to push high-fee ESG products to raise profits, and the data underlying ESG theories is unclear and subjective. 

Greenwashing is a risk to investors and could distort how major investors allocate capital to the companies and investors funding carbon reduction. Fancy suggests ESG has become top-cover for polluters and the investors invested in them. They have successfully avoided the hefty costs that carbon taxes would impose on them by pretending to embrace ESG. He uses a sports analogy: ‘it’s much better to play clean if you have a referee [carbon taxes]. But if you don’t have a referee, play dirty.’

I particularly love this quote from an interview Fancy gave, discussing ESG and carbon taxes:

“Finance does what finance does. It’s about finding the best profit opportunities. There is a reason Goldman Sachs does not try to IPO the Sinaloa Cartel. If it is legal, they will surely do so, because it’s probably a really lucrative high-cash flow business. But, the reason they aren’t doing it isn’t because of some business statements or ESG policies. Nonsense. Because its illegal and they can’t.”

So how do we change and put finance back on track to save the planet?

Let’s be clear. ESG is not all bad. It has raised the flag on climate change. To a lesser extent, it’s highlighting social inequality. I see little sign its increased the tempo on improving corporate governance, however.

One thing is clear, though: ESG has become a veil for bad actors to hide behind. It’s no longer the route forward. Shut it down now.

There are several things I would propose to advance the notion. First, I concluded years ago that the only important part of ESG is the G – Governance. Any company that is well managed should be reconciling stakeholders and shareholders to optimise being a good socially and environmentally aware firm while producing decent returns. Stakeholder Society and the Friedman dictum of delivering profits to owners can meet in the middle.

Second, tax carbon emissions. This is a difficult one because it will expose the political and business cover-up ESG has provided. Companies, and the politicians in their pockets, will argue ESG verbiage is a much better way to get them to change, rather than immediately taxing them to the rafters for pollution. Yet, taxation is direct and effective.

Rather than allow big business and finance to set the agenda on what markets should deliver in terms of social amelioration and climate mitigation, I’m afraid we’re going to need some rules. It will be the Government’s job to improve corporate governance, which may well mean we need worker and other stakeholder board representation by law, and for government to change the focus of legislation from the carrot of taxonomies and ESG standards to the stick of carbon taxes.

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Bill Blain is market strategist and head of alternative assets at Shard Capital. He writes a daily market commentary called The Morning Porridge (www.morningporridge.com).

Columns are the author's own opinion and do not necessarily reflect the views of CapX.