By Jan Willem van Gelder
Since German prosecutors raided the DWS-offices last year because the subsidiary of the Deutsche Bank was greenwashing investment funds, the appeal of the ESG-concept embraced in the past 15 years by the financial sector is rapidly vanishing. Nothing to feel sorry about, as this opens the way for the financial sector to take decisive steps to play a leading role in the sustainable transformation of the global economy.
Some 15 years ago, the increasing attention for ESG in the financial sector promised to be an important step forward. ESG refers to integrating Environmental, Social and Governance factors in investment and financing decisions. Overlooking these issues can contribute to greenhouse gas emissions, human rights’ violations, biodiversity destruction and all kind of other negative impacts. Integrating ESG-factors was the response of the financial sector at the time when various NGOs in the UK, US, Germany and the Netherlands began to hold banks to account (often based on Profundo research) on the destructive impacts of their financings of, among others, fossil fuel and palm oil companies. This pressure led to the establishment of the Equator Principles in 2003 and the Principles for Responsible Investment (PRI) in 2006. The PRI aim “to understand the investment implications of environmental, social and governance (ESG) factors” and to help “signatories in incorporating these factors into their investment and ownership decisions.”
The PRI in the first place aimed to address the reputational impacts which ignoring ESG-factors could have on investors. This risk was clearly demonstrated in 2007 by the notorious Zembla television documentary “The Cluster Bomb Feeling”. It showed, based on Profundo research, how Dutch pension funds were involved in cluster munitions, environmental destruction, and child labour. The documentary caused a public outrage for months, that resonated far beyond the Netherlands. After many similar media and NGO revelations in the following years, banks and investors across the world learned to understand the relevance of managing the impact of ESG-factors on their reputations. They massively started hiring ESG-managers and -analysts, who wrote all kinds of ESG-policies and developed ESG-investment products, supported by a whole new industry of ESG-rating agencies.
Fast forward to 2023: ESG is everywhere now in the financial sector. The PRI has more than 5,000 members, representing by far the majority of all assets under management globally. All global banks have “ESG-risk” departments and investors can choose from thousands of ESG-investment funds, branded as “green”, “sustainable”, etc. Even financial regulators are warning about the impact of ESG-factors, including climate change and biodiversity, on the financial system.
Unfortunately, the rise of ESG has not resulted in massive positive real-life impacts. Admittedly, some of the worst companies had to change their plans, because banks and investors became more cautious to put their money into activities that could hurt their reputations. The positive impact of these steps on society remained more of a by-product, however, than really the core objective. Although many people within the financial sector made it appear differently.
But we are entering a new phase now. Since the German police raided the offices of DWS in May 2022, accusing the investor of greenwashing its investment funds, the whole ESG-bubble is rapidly deflating. Scientific studies conclude that the ratings of ESG rating agencies are not consistent and that the ESG expertise of financial institutions has been greenwashed as well. Media reports show that ESG investment funds continue to invest in airlines and fossil fuels. Financial regulators conclude that banks don’t do enough on climate change. And in our own studies, Profundo concluded time and again that banks, insurers and pension funds do not take sufficient action to ensure that the companies in their portfolios respect the ESG-standards of the financiers.
Meanwhile, ESG is also under fire for completely different reasons in the United States. Funded by a libertarian billionaire, Republican politicians in several states are proposing anti-ESG legislation to force investors to continue investing in fossil fuels.
Why ESG did not work
Leaving this political demonization of ESG aside, there are a few key reasons why the ESG-concept has hardly contributed to the sustainable transformation of the global economy:
Define sustainable financing and investment
Within this context, there is an urgent need to move beyond the confusing and misdirected ESG-concept and define what sustainable financing and investing needs to be. Here are four key elements:
The collapse of the ESG-concept is nothing to feel sorry about, as it might encourage more financial institutions and regulators to take decisive steps in the directions of sustainable financing and investment.
For more information, please contact Jan Willem van Gelder: firstname.lastname@example.org
(Photo: Chris Stowers on Climate Visuals)