Is it time to say RIP to ESG?

Debates over standards, transport and energy confuse the picture

‘It’s time to say RIP to ESG,’ declared one of its key proponents at a dinner hosted by OMFIF at the House of Lords. Anne Simpson, formerly managing investment director for board governance and sustainability, CalPERS, and newly appointed global head of sustainability at Franklin Templeton, explained that the environmental, social and governance movement had come of age and would be integrated into the ‘visible hand of stewardship’ for all companies and investors.

Other voices at the table pointed to a contradictory and potentially irreconcilable debate on standards and a misguided focus on transport. This is now being further complicated by the risk that the Ukraine crisis will shunt climate considerations down the priority list as well as make East-West co-operation on these issues much harder.

The dinner was attended by key influencers across sustainable finance, with the heads of sustainability and ESG investment at leading banks and asset managers including BNY Mellon, State Street Global Advisors and DZ BANK in attendance, as well as environmental groups and academics from the London School of Economics and London Business School.

Simpson highlighted the need to mainstream and take a more holistic approach to ESG across investments and capital allocation. ESG must be incorporated into the governance of all companies, funds and portfolios that asset managers oversee. Simpson emphasised the important role financial markets can play, and the power of assets in transitioning the global economy to achieve net zero. The pledge made at COP26 by 450 of the world’s biggest banks and pension funds to devote $130tn to climate action is a strong indicator of the growing commitment globally and the influence of investors in driving climate mitigation.

The increasing range of ESG standards, regulation and reporting frameworks being used by the financial sector and real economy shows ESG is beginning to be integrated into organisations’ frameworks and governance. Yet although these developments are a positive step, there is still a need for a common language on ESG products, risk management tools and disclosure metrics to support the movement of assets towards sustainability.

Current disclosure requirements are weak, lacking consistency and the potential for comparison of different companies’ performance. Tensions persist between calls for a holistic, converged and integrated approach to ESG and taking a more diverged approach that considers jurisdictions’ different starting points, national objectives and the need for policies to reflect this and appeal to global investors.

It is clear however that without some interoperability and common frameworks for green financial products and investment, asset managers face increased complexity and a lack of clear guidance on what is ‘green’. There was a sense during the dinner that progress towards the full integration of ESG into financial structures and the wider economy is in some circumstances being thwarted by current standards. A key argument was that accountancy must factor in the ‘intangible economy’ and place capital value on nature, yet the financial sector’s ability to identify stranded assets and place inventory on fossil fuels remains ambiguous.

The development of taxonomies, led by the European Union, shows a tangible commitment to net zero. Yet conflicting objectives and understanding of ESG among jurisdictions has led to a lack of coordination and divergence in taxonomy development. Participants at the dinner highlighted the contradictory views and responses to energy transition in the various taxonomies. The contention surrounding the EU taxonomy’s inclusion of nuclear power and natural gas, and differing views of France and Germany, are key examples of this.

The road to clean energy remains a fraught one. As one participant argued, until China – whose coal output reached a record high of 4bn tonnes in 2021 – stops producing and using the fuel, net zero cannot be accomplished. Furthermore, while economically developed countries continue to phase out dirty energy industries in their own jurisdictions, and at the same time subsidise investments and the extraction of oil and gas in resource-rich countries, energy transition cannot take place and the threat of assets being stranded will only rise.

Nevertheless, the heaviest emitting industries remain extremely influential. Until more emphasis, policies and regulation is directed to their divestment and transition, and as one participant noted, less emphasis is placed on factors such as electric cars and transportation – relatively low in carbon emissions – real action to divest and transition dirty industries will not take place. As long as asset managers only implement ESG to placate client demand, we cannot yet say ‘RIP to ESG’.

Emma McGarthy is Head of OMFIF’s Sustainable Policy Institute.

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