At the back of the room, a group of protestors unfurled banners and began chanting slogans. “Stop funding climate death!” they shouted.

As the audience turned around to see where the commotion was coming from, the panelists looked on awkwardly.

One of the activists accused private equity firms of killing the planet, and suggested the ESG movement was complicit: “You’re using fancy words like ESG and sustainable investment to hide the fact that 80% of your investment portfolio is in fossil fuels,” they yelled.

The conference was SuperReturn US, the stateside version of the major European private equity conference. The protestors were from Extinction Rebellion, the climate-crisis activism group that days earlier had glued themselves to various locations in and around the UK House of Parliament.

After the hubbub in New York, the panelists and onlookers were variously surprised, upset, and amused.

Many of them were also confused, as well they might be. Just a couple of weeks before the conference, the state of Texas had accused BlackRock of using ESG to boycott the oil and gas industry; now, here was a group of protestors arguing that investors were using ESG to cover up their fossil fuel holdings.

Two groups, on opposite sides of the climate change debate, but united in their outspoken criticism of ESG. How did we get here?

Under pressure

The protest at SuperReturn is just the latest example of a wave of anti-ESG sentiment that has been building over recent months.

Earlier this year, Stewart Kirk left his post as HSBC’s head of responsible investing after being suspended for a speech in which he complained that “there’s always some nut job telling me about the end of the world”.

Elon Musk called ESG “an outrageous scam” after Tesla was kicked out of S&P’s ESG index. He said the ESG movement had been “weaponized by phony social justice warriors” and pointed out that while Tesla had been ejected, the energy producer ExxonMobil remained in the index.

Meanwhile, a growing cast of characters — from right-leaning politicians to purportedly non-political investment firms like Strive Asset Management — is turning against the movement for being ‘too woke’.

Earlier this year, Florida governor Ron DeSantis banned the state’s pension funds from using ESG to make investment decisions. And in the wake of Texas’s blacklisting, Louisiana and South Carolina have also announced plans to divest from BlackRock.

“This divestment is necessary to protect Louisiana from mandates BlackRock has called for that would cripple our critical energy sector,” said the state’s treasurer. The treasurer of South Carolina, meanwhile, accused the firm of pushing a “left-wing agenda”.

Yet at the same time, groups like Extinction Rebellion — generally associated with the left of the political spectrum — are claiming that ESG is being used not to harm the energy industry but to enable asset managers to hide their investments in fossil fuels.

Mission creep

Clearly, the ESG movement is having some of an identity crisis. According to Lourenco Miranda, managing director of ESG solutions at consultancy firm Eisner Advisory Group, part of the problem is that the meaning of the term has shifted in recent years.

“ESG was previously marketed as something that would have a direct impact on society, which is not necessarily the case,” he told 9fin.

Many still equate ESG with sustainable investing or products such as green bonds, which are generally designed to funnel money directly to sustainable projects. But in reality, ESG is simply a framework for assessing companies’ exposure to environmental, social and governance risks.

Not everyone realizes this. And among those that do, not everyone agrees that this equates to improved shareholder value, or that it leads to societal benefit.

Some anti-ESG firms, such as Strive Asset Management, argue that changing society for the better is the job of politicians, not the market. But many political efforts to improve sustainability have hit a wall — particularly in the energy space.

By suddenly increasing reliance on domestic energy production, the war in Ukraine has all but killed President Biden’s ambitious call to phase out fossil fuels in the US. However, even before the conflict began, the plan was widely criticized for being unrealistic.

Meanwhile, the UK is considering imposing a de-facto windfall tax on renewable energy companies, which do not rely on natural gas and have benefitted from surging demand in recent months. Some have suggested the move could skew investment towards fossil fuels.

Mismatches

In the credit markets, there is growing interest in new forms of debt that codify ESG factors into documentation to incentivize positive action.

But in the realm of leveraged finance, issuance of such instruments — whether debt that directly finances green projects, or sustainability-linked debt that reward positive ESG action — remains low even as demand grows, as 9fin has previously reported.

Furthermore, some issuers of sustainability-linked debt have managed to engineer structures that are somewhat toothless.

Earlier this month, 9fin’s highlighted the case of Graanul Invest, an Apollo-backed wood pellet producer in Europe that issued a sustainability-linked bond last year. The interest rate was designed to step up if the company missed emissions-reduction targets.

However, the target was set so low that Granuul met it by the end of the year. The threat of a coupon step-up disappears when the target is met, so the incentivize to reduce emissions is no longer effective.

In ESG investing, inefficiencies like this are abundant. Just to pick one example, buyside sources regularly complain to 9fin that jumbled rating methodologies often lead to companies in less sustainable industries receiving higher scores than credits that are obviously greener.

Applying formulaic methodologies to an idea as broad-ranging as ESG is fraught with complication. It is an art rather than a science, said Miranda.

“Credit ratings have a specific and clear target, like when you measure default and the model is predicting that,” he said “In ESG, we don’t have prescribed mechanisms to identify what a crisp state of ‘good’ ESG is and what isn’t. The modeling is more judgmental than statistical.”

So ESG is extremely hard to define. And yet, a growing number of institutions have made it clear that they will no longer do business with companies that don’t live up to ESG standards.

“We do not participate in underwriting debt for oil and gas companies [with operations in the Amazon or Arctic] which have not implemented a credible transition strategy,” said Hervé Duteil, chief sustainability officer for the Americas at BNP Paribas.

“Companies without a credible transition strategy will gradually face more difficult access to capital, resulting over time in an increase in costs,” he said.

Transparency urgency

This brings up another force that has driven the growth of ESG and makes its current identity crisis all the more frustrating: urgency.

The movement may be having a bad year, but it doesn’t seem like it’s going away any time soon. For one thing, it’s now codified into European law through the Sustainable Finance Disclosure Regulation, which makes it hard for large institutions in the US to ignore it.

And yet, there is still little clarity around how to implement it. The recent politicization of this debate makes this harder; tribalism and emotionally-charged rhetoric increase the pressure for market participants to have an opinion, but do little to help them form one.

Tess Virmani, executive vice president of public policy at the Loan Syndications and Trading Association, suggested that the desire for transparency is one thing that unites people across both sides of the ESG debate.

“A lot of the political concern around ESG is that the entire financial sector is trying to achieve a certain result,” she said at a recent DealCatalyst event. “What’s universally found, and apolitical, is that investors want ESG disclosure regardless of whether it’s an ESG investment or not.”

“Managers are just the intermediaries between investors making these requests. I think it’s a bit of a pendulum swing, but opponents think everyone is trying to do impact investing, and that’s not reflective of the credit space.”

The problem is that facts and good-quality data are hard to come by. Using 9fin’s new ESG Company Data tool, we recently found that companies in the leveraged credit space are reporting less than 45% of key data points.

Opaque

Private equity firms, which Extinction Rebellion appeared to accuse of greenwashing during their SuperReturn protest, are also not as transparent on ESG as they might be.

“The lack of information right now makes accountability challenging,” said Alyssa Giachino, research director at the Private Equity Stakeholder Project.

In a recent report, PESP estimated that PE firms have invested over $1trn in energy companies since 2010, and that ten of the largest sponsors had at least 80% of their energy portfolios in fossil fuels as of October 2021.

“[We] are calling on the industry to be more transparent, and for PE firms to publicly disclose their holdings and environmental impacts,” Giachino told 9fin.

All the firms assessed in PESP’s report have websites touting their dedication to ESG and a myriad of similar initiatives. However, the report also highlighted a lack of standardization and transparency surrounding these firms’ ESG metrics and practices.

The recent noise around ESG has created plenty of headaches for the financial industry. Legitimate questions are being asked; they need careful examination, so it may take time for things to settle.

But just like fossil fuels, time is in increasingly short supply.

“Oil and fossil fuels are direct contributors of many new technologies we have today since the Industrial Revolution,” said Miranda. “We are at a moment where we transition from this level of dependency to no dependency. If we wait until 2050, that doesn’t work.”