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Jack David

Welcome to The Olive Tranche. In this new 9fin feature we’ll be attempting to steer a course through the choppy waters of ESG as it relates to LevFin. The intention is to encourage open discussion on some of the stickier topics. Don’t hesitate to get in touch with your thoughts. 

There has been a hell of lot of energy used (or, burned) debating whether or not we stop using the acronym of ESG. It's not just the anti-ESG movement calling for ESG to be dropped — I've heard companies with ESG in their name declaring it’s outdated and we should move on from it. 

But is this a conversation worth having, or is it a distraction from the issues it’s trying to solve? 

The term ESG was first coined in 2005 in the Freshfields report, a legal framework written by law firm Freshfields Bruckhaus Deringer and the United Nations. The report asked a question about fiduciary responsibility: “Are the best interests of savers only to be defined as their financial interest? If so, in respect to which horizon?” pointing to the risk of the tragedy of the horizon.

In some cases, the ESG acronym has been highjacked as a marketing tool. This is a real problem and has been highlighted by high profile figures such as Tariq Fancy, former global chief investment officer for sustainable investing at Blackrock and Desiree Fixler, former group sustainability officer at DWS. To be frank, yes, loopholes and greenwashing are used by companies and investors in scoring and labelling. But these are inevitable outcomes of anything that exists in a capitalist system: if it is popular, it will be exploited.

The argument that we shouldn’t lump opposing factors together in analysis to get one overall score or objective is also valid and important to recognise. But environmental factors cannot be considered in isolation from social ones, so tackling them together still makes sense. 

The main pushback against ESG is coming from the political far-right, meaning those with conservative views likely aligned to neoliberal economists such as Milton Friedman. These economic models served many in the global north in the last century, which may explain the difficulty we are having moving on from them. 

But as Kate Raworth points out in Doughnut Economics, these economic theories are not aligned to Earth’s natural systems, meaning they are not fit to tackle the existential threats we face. Nor are they socially sustainable, given the growing wealth disparity in advanced and major emerging economies.

Tariq Fancy calls for governments to take the responsibility away from businesses, but having better regulation and incentives should be there to keep businesses accountable for their responsibilities, an important distinction. Even in Fancy’s world, these government actions will still fall under the bracket of 'sustainable finance', so why the campaign to drop ESG when what he is really calling for is to stamp out greenwashing? I’m no fan of corporate cliches, but 'don’t throw the baby out with the bath water' springs to mind.

There is also a danger that once an idea like this takes hold, everyone wants to be seen as up to date, so jumping on the drop-ESG bandwagon seems like staying ahead of the curve.

So, should we drop ESG? Well, consider the latest reports on global tax, which show evasion is rife, yet breaching tax laws and paying subsequent penalties are considered a normal part of running a business. Does that mean we should do away with tax, because it’s a complex, imperfect system?

It’s also worth asking, what is the anti-ESG movement advocating for instead? It's signalling to companies and investors that, actually, none of this matters, climate change isn’t a real risk to capital nor the planet and the global south isn’t their problem; it’s better to just go about thinking about the bottom line. Another perspective is that good companies will do this stuff anyway, but we all know that isn’t how capitalism works. Any step in that direction is a step away from a world where we don’t breach our natural planetary boundaries and people from all backgrounds and geographies enjoy human rights, neither of which are particularly radical or woke ideas. 

It’s true that recently there have been big outflows from funds labelled as ESG, or sustainable, but this can be misleading. Sustainable funds have been generally heavy on tech stocks and light on energy, so when tech starts to dip and something like the Russia-Ukraine war breaks out, it makes it appear as if ESG is underperforming. This doesn’t reflect the financial performance of companies strong on ESG, which is mixed and highly nuanced, nor does it reflect that, for example, investment into low-carbon technologies is at a record high.

Some of the scrutiny around ESG has led to a tightening up of the industry and a crackdown on what should be labelled sustainable, which is positive. For the most part, the direction of travel hasn’t changed for finance, even in the US, except people are calling ESG something more palatable to both sides of the political spectrum, like ‘non-financial information’. Asset owners are still increasing their allocation towards ESG strategies and, in European high yield, sustainable debt issuance has broadly stayed the same relative to overall issuance since 2021.

Ultimately, it doesn’t matter if you label it ESG, sustainability, impact or name the underlying factors like climate change and human rights. At its core it is all an attempt to better align company operations to outcomes that benefit us all, and help us mitigate existential threats. It’s useful to have a shared term for these goals. I don’t think it really matters what we call it as long as it describes the goals, so it may as well be ESG.

As discussed, regulation should be used to steer ESG away from being a marketing tool. The struggle to define 'sustainable investment' under the SFDR to label funds is one case to consider. 

Is defining what this arbitrary term means really the best use of resources, and can any single definition ever satisfy the complex requirements needed to achieve environmental and societal goals? This is where the drawbacks of the SFDR, and the fact it was never meant to be a labelling or marketing tool in the first place, are clear. Definitions of a sustainable investment vary widely from MSCI’s attempt, which includes just 300 companies all in European countries, to Cardano’s, which includes 35-40% of the investable market. 

Would it not instead to be better to clearly name and define what it is you’re trying to achieve with a fund or investment, provide transparency over the methodology of how the fund plans to achieve this, and then have that label and methodology assured against accepted standards by an independent third party? Preferably not one paid by the company. Perhaps something like the Science Based Target initiative (SBTi) for funds (Science Based Fund Initiative?)

The market standard for labelling any given objective will surely come about with time, but in the meantime transparency and assurance is the route to achieving this. 

Perhaps we’ve been lucky, or perhaps we hire particularly well, but after just a few months of training, new 9fin analysts are very capable of consistently spotting greenwashing in company reports. If you do choose to make a splash about your sustainability credentials it shouldn’t be a risk if you do the following three things:

Create a company culture that prides integrity, honesty and ethics

Hire and train people with the right sustainability subject-matter expertise for your company, capable of critical thinking and analysis

Integrating these individuals into all verticals and levels. Especially your marketing team

If you have these things in place, it would be very difficult to claim that you’re doing something that you’re not, or not doing something that you are, unless you’ve decided to take the risk for marketing purposes.

The Olive Tranche — Definitions and distractions in ESG

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