by Torsten Becker & Valerie Muschik
One common misconception that we’ve come across repeatedly in talks about our work is: “So, what you are doing is ESG investing?” No, we don’t do ESG; we do impact investing! That means our investments have a measurable positive impact on people and/or the environment.
The seemingly harmless question about our daily work often feels like it’s coming with a subtle accusation of greenwashing. Over time we became more and more aware of the many uncertainties around the concept of ESG and the “impact” of ESG investing. These uncertainties have also negatively influenced the image and perception of investments that are actually sustainable and impact-oriented.
We thereby realized how little is known to the broad public about the original purpose of ESG investing – while at the same time ESG labels and terminology are omnipresent, especially in the finance industry. Of course, a handful of sustainable banks and asset managers offer truly green products. But most of them don’t. Unfortunately, it is often the investors’ own unawareness that facilitates greenwashing. Unawareness of the actual impact of supposedly green investment products – which hence also becomes an obstacle for truly impact-oriented investments.
Admittedly, in our last article which critically examined ESG funds, we ourselves haven’t really addressed and clarified this issue. So what exactly is the problem with ESG investing? Why doesn’t it spark the positive impact that many investors are probably hoping for? And is it even greenwashing if investors are not actively misled, but simply left in the dark? We hope this little addition (2.5) will shed some light on the topic.
One more thing in advance: The funds described below are not always necessarily labeled “ESG”. Just as often they are advertised as “sustainable“. The content and problems, however, remain the same in many cases.
ESG: 3 letters for more sustainability?
But first things first. ESG has become famous especially through scandals in the financial sector; however, the concept doesn’t necessarily have to do with investing. ESG is a pivot towards more environmental conscience, entrepreneurial responsibility and a new business culture that was first introduced in the real economy (production, trade, services). And there are many companies that indeed take that responsibility very seriously, develop ambitious strategies and work hard on their implementation.
Not least because there is no standardized set of criteria for ESG, the success of different measures is hard to track or compare. Whether a 10 % reduction in CO2 emissions is a good achievement or insufficient depends, amongst other things, on the sector; if an increase in female managers from 1 to 2 (+100 %) is enough depends on the size of the company, and so on. In the end, unfortunately, there are also companies that use ESG as a pure marketing instrument without any intention of making a change for the better. Greenwashing has become the synonym for all forms of deception, even if they are taking place in the social or governance sphere. Who knows, maybe the Corporate Sustainability Reporting Directive (CSRD) will provide more clarity in the future.
In the real economy, ESG refers to the impact of a business on environmental, social and governance factors – from 0 % to 100 % (or maybe more accurately: -10 to +10). However, this doesn’t mean that companies that take ESG seriously and are “on the right track” have a good ESG rating – or the other way around!
A misunderstanding with consequences
Let’s take a look at the financial industry now. ESG ratings are the basis for ESG investing, meaning ESG-compliant investment products sold in large amounts by banks and asset managers. A good ESG rating is relevant for a company to get included in a so-called ESG fund. At this point, though, it comes to a common misconception on the part of many investors – not to say a deliberate misleading of investors by large parts of the financial industry, which has been barely sanctioned by legislation or regulation so far.
A good ESG rating doesn’t mean that the respective company is performing particularly well regarding ESG. Thus, by investing in an ESG fund, investors are not doing any good for people or the environment (maybe by coincidence, but not in a targeted way). A good ESG rating rather means that expected future developments regarding the environment, social issues or governance (according to the rating agency) will not negatively influence the financial performance of the company. In other words, by investing in an ESG fund, investors make sure that their money is with companies whose return expectations (share price, dividends) won’t be (greatly) affected by ESG influences.
That’s what these ratings were made for in the first place: to help investors assess return expectations and risks of losses, respectively. They were not intended to support investors in understanding whether their money is used to make the world a better place. That’s a fundamental difference – not to say, the complete opposite – and might come as a surprise to many people out there. This fact, however, explains the portfolio composition of such funds, which often contain big oil and gas companies.
An article by Ken Pucker and Andrew King titled “ESG Investing isn’t designed to save the planet” gets straight to the point: “Most people assume that ESG Investing is designed to reward companies that are helping the planet. In fact, ESG ratings which underlie ESG fund selection are based on “single materiality” — the impact of the changing world on a company P&L, not the reverse. Asset management firms have been happy to let the confusion go uncorrected — ESG funds are highly popular and come with higher management fees. The danger with ESG investing is that it might convince policy makers that the market can solve major societal challenges such as climate change — when in fact only government intervention can help the planet avoid a climate catastrophe.”
What makes things worse: Obviously, there is not only one ESG fund. Different funds follow different investment strategies, use various ESG definitions and rating agencies, are more or less willing to share information, and so on. Or, in the words of Harald Walkate in his „10 questions to ask the manager of an ESG fund”: “To sum up the problem with ESG funds: you might be tempted to think ‘all roads lead to Rome’, as the familiar saying goes, but sadly this doesn’t fly in ESG. Because, in ESG, not everyone wants to go to Rome, some want to go to Tokyo, some to Rio.”
Nothing but greenwashing – or maybe not?
Cynically speaking, one could ask if it’s even justified to call the case of ESG funds greenwashing. Whether the misguidance of investors is actually just a lack of active clarification regarding the investment strategy of the funds. Whether the use of a green logo and the omnipresent (originally positively connoted) acronym ESG should be called fraud or rather good marketing within the given legal framework. For the financial industry, there is no reason to change its strategy at this point. The current version of ESG generates large profits. Expecting the industry to change on moral grounds is probably not more than a utopian idea.
There are clear results and recommendations from science, too. The capital market will not develop altruistic traits by itself to avert the climate catastrophe (or other undesirable developments). Clear legislative and regulatory guidance is needed, not least when it comes to the advertising and composition of ESG funds. Millions of people contribute to the destruction of the earth with their money, actively but perhaps unknowingly. The actions of the financial industry put the common welfare and livelihoods of future generations in jeopardy. If this constellation does not require sovereignty – what else does?
Once again, it’s up to us – to take a close look and act ourselves
Unfortunately, political efforts are barely targeted and only slowly progressing. In our previous articles, we already elaborated on the practical challenges and potentially low effectiveness imposed by different decrees and instruments of the EU Taxonomy. And in the current German parliament, too, there are movements aiming at preventing any restrictions for the economy or industry…
Admittedly, there are also developments in the right direction. Since the beginning of August, banks in Germany have been bound to ask their clients about their interests and preferences regarding sustainable investment – and to give advice, accordingly. Whether bank advisors have been adequately trained, when there will be clarity about requirements and definitions, if the (so far) missing impact of ESG investments will be transparently disclosed – and if eventually real sustainable investment products will be offered – remains to be seen. We might only be able to evaluate the success of this measure in hindsight in a few years’ time.
The good news: we can all do something already today! Alternative rating agencies assess the positive or negative impact that businesses have on people and planet. Those agencies virtually turn the data sets around and put them in the right order. They act transparently and independently and haven’t been hired by the assessed companies themselves. Impaakt, for example, involves civil society by collecting data from more than 50,000 individuals worldwide, which enabled them to create easy-to-understand impact assessments for several thousand companies already. They are accessible free of charge. Everybody can use this data – and contribute to it!
