ESG: From Boom to Doom
How the ESG movement is failing and where to go from here
The ESG boom has rapidly expanded over the years growing to a $35 trillion global market set to reach $53 trillion by 2025 (Diab & Adams, 2021). More and more investors are riding the wave of evaluating investment opportunities by taking into account environmental, social, and governance factors alongside traditional financial metrics. However, a look beyond the surface depicts a different story of corruption masquerading as social responsibility.
The rise in popularity has caused many corporations to merely pose as progressive socially responsible firms when their actions below the surface speak differently. Take ratings for example: all firms are given a three-component rating for each letter in ESG and these scores are all relative, meaning an oil and gas company can achieve a decent ESG rating if it’s, let’s say, emitting 0.0000023% less carbon emissions than its industry competitor. This subjectivity makes it simple for companies to manipulate the ratings. The oil and gas company can simply host a one-day volunteer event for its employees and its “social” score will expedite, causing its composite ESG score to rise and the company is thus labeled as “socially responsible” while massively contributing to climate change. ESG funds today lack oversight and the sustainable index funds that claim a diverse portfolio of socially responsible companies are simply a pool of companies that are taking limited action to positively contribute to society and hyping up their bare minimum actions. Being marginally less harmful compared to the last quarter or a competitor doesn’t make a company sustainable. The manipulations of ratings contribute to this insidious greenwashing trend where sustainable funds like iShares ESG Aware MSCI USA ETF are made up of companies like Exxon Mobile and Occidental Petroleum. Investors therefore need to raise the standards for these funds by looking under the hood of “sustainable” companies and assessing more closely just how sustainable they really are.
ESG has a dangerous way of both consciously and unconsciously convincing the public that corporations can solve climate change and that when we invest sustainably it causes the world to get better. However, investing in sustainable mutual funds doesn’t necessarily mean there is increased funding towards social and environmental issues. Investors buying shares in a “high ESG score company” means the seller of those shares will be receiving that money, not the company itself. ESG investing therefore consists of the speculation of companies’ potential to do marginally better and the pouring of trillions of dollars into this belief when the data shows that companies are not taking steps to fundamentally improve their operating models to limit negative environmental impact. They are incentivized to do the bare minimum by the subjective ESG standards and are over incentivized to broadly market their limited actions. The green branding leads ordinary citizens to believe that these companies can fix large scale issues, that if investors just buy a couple hundred more shares in the “sustainable index” that climate change will be solved. This assumption causes people to believe that widespread government intervention is unnecessary to tackle climate change and only gives more power to corporations who in the past have mostly if not always abused it. Corporations are just not incentivized to address climate change and even when investors put pressure and they don’t act aggressively enough since they’re more focused on next quarter’s earnings, and if lowering carbon emissions means a lower top line, corporations are unlikely to act in environmentally conscious ways. Climate change, however, being an issue that will be even more pressing twenty to thirty years from now, is one that needs to be addressed by large-scale intervention from the federal government which is designed to address these pressing issues, not corporations incentivized to only improve next quarter’s earnings. Similar to Covid-19, if left to businesses and corporations who are incentivized to merely appeal to shareholders, the negative impact of these issues would have been and will be even more severe. The way that industry leaders like Larry Fink address the public suggest that the private sector is the best equipped to handle these issues without addressing the fact that not only are ESG funds greenwashed and don’t actually contribute to a greener, more sustainable world, but that there are severe limitations in relying on ESG investing to address global issues like climate change. While government intervention does not sit well with the majority of Americans, the world can’t rely on corporations who are too incentivized to beat next quarter’s earnings expectations to address large scale, long term issues like climate change.
While ESG investing doesn’t live up to the hype it claims to be, there is hope for improvement. The recognition of its flaws by more and more research today is essential in holding funds and corporations accountable. When the public pushes for higher standards and more urgent action, corporations will act accordingly. It is up to investors and citizens to recognize the flaws of ESG investing and accept the inevitable need for widespread government interference to ensure the safety of citizens and the environment years down the line.
*Edited by Andy Colando
Works Cited
Diab, A., & Adams, G. (February 23 2021). ESG assets may hit $53 trillion by 2025, a third of global AUM. Bloomberg.com. Retrieved October 19, 2021. https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/
LightspringClose (September 22 2021). ESG Is Huge and Terribly Flawed. Now What? Greenbiz, Retrieved October 19th, 2021 https://www.greenbiz.com/article/esg-huge-and-terribly-flawed-now-what
Grant HarrisonGreen Finance & ESG AnalystGreenBiz Group (September 23 2021). ESG Is Under Attack, and That's a Good Thing. Greenbiz, retrieved October 19, 2021 https://www.greenbiz.com/article/esg-under-attack-and-thats-good-thing
