ESG: a Bubble or a Paradigm Shift?
It might seem odd for the Environmental, Social and Governance (ESG) section to question its very own importance and relevance in finance. But I think it’s crucial that nuance is presented when discussing such complex and significant issues.
A sceptic of ESG investments, Robert Armstrong, the Financial Times’s US Financial Commentator, argues that environmentally conscious investment decisions are not to be confused with environmentally conscious consumer decisions (e.g. buying an electric car). On the FT’s Behind the Money podcast, he described ESG investments as a “dangerous placebo” that “make[s] people feel good for doing essentially, very little”. His point being that consumption decisions have a more direct impact on the companies you choose to buy or not buy from. He went on to say, “There’s always someone else to buy those shares at the price you want to sell them”.
However, I think it’s imperative to draw another line between short- and long-term investment decisions. Yes, in the short run, if I choose not to buy shares in an Oil company like ExxonMobil, they will easily find someone else to buy them. But if the underlying trends do not favour the longer-term success of this company, the person buying those shares is just making a poor long-term investment. As costs for oil extraction rise relative to renewable energy production, if these companies do not diversify, they will not be successful in the long run.
ESG investment does not have the same immediate impact on companies as choosing to avoid unethical fast fashion brands does, for example. But it represents the longer-term trend in finance flowing towards companies that are truly analysing and reducing their negative stakeholder impact. The top-down change that ESG is incentivising, will empower consumers to make the same positive choices Robert Armstrong spoke about (when explaining that consumer choice has a more direct impact on companies).
The rapid rise in ESG investments has led some sceptics to draw parallels with the exponential rise in investment in mortgage-backed securities before the 2008 Financial Crisis. Coupled with other similar factors such as dramatic shifts in public policy and a new variety of seemingly innovative yet indistinct investment products. Add to this, lagging regulation causing a current lack of transparency in reporting metrics, and it may seem all too familiar. The below charts show the current ESG market next to the mortgage-backed security market pre-Financial Crisis – showing an alarmingly similar trend in the last two years.
The World Economic Forum is in the process of providing clear ESG metrics for both institutional investors and consumers. New accounting frameworks discussed at COP26 such as the International Sustainability Standards Boards (ISSB), will help create a foundation for transparent and extensive sustainability disclosure standards. This will provide a clearer picture of what defines an ESG investment, helping to reduce any greenwashing being conducted in the sector.
Moreover, governments play a role in absorbing the capital flows, policy changes can incentivise the private sector to act quickly. Additionally, public investments and government targets (e.g. net zero commitments) can give direction to capital to create real outcomes, rather than fuelling a speculative bubble.
ESG investing may not be perfect, and these trillion-dollar capital flows are certainly not all making a difference. However, they are representative of a longer-term paradigm shift in the investment market. Business practices are more transparent than ever, it is crucial for businesses to be seen considering their wider stakeholder impact rather than just increasing profit for the shareholder.
Whether this leads to actual changes benefitting stakeholders is down to government regulation that ensures ESG is a stringent and dynamic metric – avoiding greenwashing. In the face of a global crisis, something is certainly better than nothing. The fact that we are talking about ESG, and all companies have to consider it, regardless of if they act, is a positive.
ESG is a prerequisite for empowering greater consumer action, making sustainable choices accessible and simple. However, it is firstly down to more powerful economic agents, like governments and institutional investors, to endorse ESG action as a prudent long-term competitive business decision, not an ethical choice.