ESG – Time for a Complete Rethink

Blain’s Morning Porridge – August 25^th 2021:  ESG – Time for a Complete Rethink

“It seemed a bit bizarre to be flying around on a private jet in order to hock, of all things, low-carbon investment products.”

This morning: ESG is a marvellous concept appallingly executed. To understand how it’s gone wrong I recommend Tariq Fancy’s rant about his time as Sustainability CIO at Blackrock. To figure out how we actually deliver climate-change mitigation, social amelioration and better corporate governance, and avoid these lofty concepts being hijacked and suborned by business and finance interests, we need to replace the carrot of ESG with the stick of Carbon Taxes and Corporate Legislation. Time to get real and dispense with ESG claptrap.

Ever since I started writing the Morning Porridge back in 2007 – trying to explain to my bond-buying clients the consequences of the then unfolding banking crisis and the opportunities it presented – I’ve been amazed at just how inefficient markets can be, how distortions are often ignored, groupthink dominates strategies, and sheer laziness, (a lack of “intellectual curiosity” as one despicable boss put it back in the 1990s), leads to all kinds of market tomfoolery.

Markets really are about the madness and behaviour of crowds. It’s very different to what I was taught back in the early 1980s when economics whittered on about “rational expectations”. I’ve learnt there is nothing particularly rational about the way market participants tend to think.

During the Second World War a study of soldiers figured only about 3% of frontline troops actually fought to kill. The rest were followers. So it is in finance. The bulk of market participants go with the flow. They don’t ask the difficult questions and they don’t call out obvious inconsistencies. These sheep inevitably get rounded up and fleeced by the tiny number of wolves. It works because market participants are attracted to well marketed big ideas, but run with them without really appreciating the consequences of the hype they’ve bought into.

A number of distortion themes have particularly dominated markets over the last few years.

• The first is monetary distortion, which has utterly dislocated the pricing mechanism of markets.
• The second is ESG – Environmental, Social, Governance – based investing, which has become rather like the Spanish Inquisition in its determination to root out and punish unbelievers and burn them as heretics.

I am such a heretic.

ESG has become a particularly dangerous notion. Regular readers of the porridge will know I have a very uneasy relationship with the concept. Although I absolutely believe in the science of climate change, am probably the last Clause 4 Socialist left working in the City of London, and will only invest in companies that can show pristine corporate governance, I find ESG to be a very poorly constructed edifice. I’ve long believed many ESG proponents have been feathering their own nests.

I’m not the only person who sees it.

This week we’ve seen an incredible post by Tariq Fancy: the Secret Diary of a “Sustainable Investor”. He’s the former head of Sustainable Investing at Blackrock – from 2018-2019 – the largest fund manager on the planet, which boss Larry Fink has committed to ESG goals. Fancy resigned when he figured ESG is riddled with inconsistencies, dubious motivations and concluded its “a dangerous placebo that harms the public interest.” (Let me be clear – I have no problem with Blackrock. I seriously admire the firm. But to be fair… I’d like to earn fees from them…)

Fancy has called ESG “marketing hype” and “a dishonest promise”. Among the many issues he has identified are:

• Financial Institutions have obvious motivations to push high fee ESG products to raise profits. (In his essay Fancy describes Blackrock iShares executives pushing ESG ETFs purely on the grounds of the additional fees they could generate in a competitive sector.)
• The data underlying ESG theories is unclear and subjective.
• Suppliers – from rating agencies, consultants, index compilers, data vendors, are all jumping on the ESG bandwagon to reap their share of the returns.
• There is no evidence that Greenbonds achieve anything when green bond issuers use other funding to keep doing “bad stuff”.
• Greenwashing is a risk to investors – and could distort the way in which major investors allocate capital to the companies and investors funding carbon reduction.

Fancy suggests ESG has become top-cover for polluters – high carbon emitting companies, and the investors invested in them. They have successfully avoided the hefty costs that carbon taxes would impose on them, by pretending to embrace ESG. He uses a sports analogy: “it’s much better to play clean if you have a referee [Carbon Taxes]. But if you don’t have a referee, play dirty.” Which is exactly what greenwashing, hidden behind ESG, allows. He is spot on.

In an interview Fancy gave discussing ESG and Carbon Taxes I particularly love this quote: “Finance does what finance does. It’s about finding the best profit opportunities. There is a reason Goldman Sachs does not try to IPO the Sinaloa Cartel. If it is legal, they will surely do so, because it’s probably a really lucrative high-cash flow business. But, the reason they aren’t doing it isn’t because of some business statements or ESG policies. Nonsense. Because its illegal and they can’t.”

Perhaps his most telling line Fancy learnt during his short-time was Blackrock was: “Reacting with denial, loose half-measures, or overly rosy forecasts lulls us into a false sense of security, eventually prolonging and worsening the crisis. And yet Wall Street is doing just that with climate change, craftily greenwashing the economic system and delaying overdue systemic solutions, including those intended to combat rising inequality and the insidious political risks it creates. It’s clear to me now that my work at BlackRock only made matters worse by leading the world into a dangerous mirage, an oasis in the middle of the desert that is burning valuable time.”

So how do we change and put finance back on track to save the planet?

Let’s be clear. ESG is not all bad. It has raised the flag on climate change. To a lesser extent it’s highlighting social inequality. I see little sign its actually increased the tempo on improving corporate governance however.

Over the years I’ve ranted about ESG many times, but the search function on the www.morningporridge.com website isn’t quite the state-of-the-art search-tool I was hoping for. Back in March it was fuming about Holier than thou ESG, and earlier about ESG’s chaotic evolution, the incentivisation of “Greenwashing”, and how unbalanced it all is.

I’ve mocked my own UK government for its issue of Green Gilts. Really? What did they achieve except giving the Chancellor an opportunity to brag about launching them? Finance professionals in the gilts market are utterly bemused by them – pointless is their conclusion, but because the Europeans were doing them, Britain had to do them.

I am still furious that the govt minister in charge of the COP26 party in Glasgow later this year threw his toys out the pram to stop a perfectly sensible and necessary UK metallurgical coal mine project that would have created good jobs, cut carbon miles and cut costs for the UK to make our own steel rather than importing it from China. I’m told the minister threatened to resign if the coal mine wasn’t stopped because his “optics” wouldn’t look good if the UK was digging a mine.

ESG has become a veil for bad actors to hide behind. It’s no longer the route forward. Shut it down now.

There are a number of things I would propose to advance the notion:

• I came to the conclusion years ago that the only important part of ESG is the G: Governance. Any company that is well managed and governed should be reconciling stakeholders and shareholders to optimise being a good socially and environmentally aware firm while producing decent returns. Stakeholder Society and the Friedman dictum of delivering profits to owners can meet in the middle.
• Tax Carbon Emissions. This is a difficult one because it will expose the political/ business coverup ESG has provided. Companies, and the politicians in their pockets, will argue ESG verbiage is a much better way to get them to change, rather than immediately taxing them to the rafters for pollution. Yet, taxation is direct and effective.

Rather than allow Big Business and Finance to set the agenda on what markets should deliver in terms of social amelioration and climate mitigation, I’m afraid we’re actually going to need some rules. It’s going to be governments job to improve corporate governance which may well mean we need worker and other stakeholder board representation by law, and for government to change to focus of legislation from the carrot of taxonomies and ESG standards to the stick of Carbon Taxes.

I can just imagine how the US coal, oil and gas shills in Congress and the Senate will respond to proposals that polluters pay… Not positively.

Five Things to Read Today:

FT – Robert Armstrong: The ESG Investing Industry is Dangerous

FT – Top T Rowe Price fund manager David Giroux cuts stocks exposure

WSJ – Euro Near Nine-Month Low as Fed, ECB Policies Diverge

Bberg – The Fed takes climate change seriously

Bberg – Powell should send a message on phasing out QE

No Porridge Thurs/Friday. Today – out of time, and back to the day job…

Bill Blain

Strategist – Shard Capital