Bonfire of the Vanities - the ESG Edition

Are we really in an ESG Apocalypse?

Geneva, 2004. Post-UN meeting, I found myself in a bar, swirling my drink and engaging in a familiar dance of bureaucratic banter. Across from me sat Paul Clement Hunt, the suave head honcho of the UN Environment Program Financial Initiative. While the UN world was still a maze to me, navigating the murky waters of international non-governmental organizations (NGOs) was old hat thanks to my days as a project manager wrangling various International Standards Organization (ISO) management standards such as ISO 9000 and 14000.

Our small volunteer crew of asset managers with the Asset Management Working Group (AMWG) had, in conjunction with the Global Compact members and UNEP staff, cleverly shed the clunky 'Socially Responsible Investing' (SRI) label for the sleeker acronym 'ESG,' for environment, social, and governance factors, hoping it would grease the wheels of acceptance in the cutthroat world of investment committees. After all, who doesn't care about risk, right? However, getting the industry to consider environmental or social issues in finance at the time was like herding cats on roller skates. 

I asked Paul where our ragtag band fit into the labyrinthine UN structure now that Kofi Annan had lured in some big fish for what would become the Principles for Responsible Investment (PRI). These 'asset owners,' the pension funds with the real clout, had been a tough nut to crack. And they definitely didn't want to share their table with the "‘staff' - us lowly asset managers.

Paul's response was as blunt as a sledgehammer: "Depends if you guys want to be the PRI's bitch." Ouch. But amidst the diplomatic niceties and doublespeak, I appreciated the refreshing dose of honesty. Let's face it, large NGOs were known for their bureaucracy rather than their brevity.

Yet, despite the odds, we'd managed to rope in some top-notch sell-side firms (brokerages that pedal research in return for company access and trading) to link ESG factors with materiality—a core concept in the industry—and we were gearing up to tackle the financial final frontier of fiduciary responsibility.¹ But Paul's words lingered—the game was already changing, and with the PRI waving its vague banners of virtue, where was this all going?

Fast forward to 2024, and ESG investing is having its very own postpartum, with much nausea and psychological trauma. Thrashing about to retain its foothold on legitimacy amid changing interest rates, index funds, pension politics, and populism—confused with a veritable alphabet soup of new climate reporting standards and net zero pledge backtracking. All this is great for consultants, rating companies and index providers, but emissions remained stubbornly high, and somehow the big fish still own all the same stuff. ESG integration has become table stakes in the industry, but sustainability seems as far away as ever. Was this the change we had envisioned 20 years ago?

Well, its complicated (sigh). If you ask today’s ESG critics they would suggest that the idea of change was never in the playbook, like ESG was cooked up during some two-day retreat at a risk management institute. I pointed out in a note back in 2019 that this was complete fantasy. 

Sustainable investing has always aimed to tackle the ‘big issues,’ in other words, to have positive impact. Take a look at some of the early work at the UNEP FI which is chalk full of high-minded intent and fancy talk². Strip that away what ESG basically boils down to is good old capital protection. Important? Sure. Revolutionary? Not so much, especially when capital is concentrated in the hands of the few, not the many.  

And if we’re all nodding along that broad indexes are steering us toward a land of misplaced priorities, then why is everyone so obsessed with following them? It’s almost like calling yourself a ‘sustainable’ investor while clinging desperately to those indexes is a bit... contradictory, don’t you think? The avalanche of ESG-flavored, index-hugging products out there shows that the industry is all-in on the “risk management” part of sustainability. But when it comes to admitting that the real goal was to actually make an impact? Well, let’s just say we’re still working on that.

This all seemed like a minor detail back when sustainable investing was riding high on the "win-win" narrative: do some good, make some dough—easy peasy! It was all smooth sailing until COVID decided to show up and turn the economy on its head.  When money was flowing like water and borrowing for growth investments was basically like finding loose change under the couch cushions, sustainability funds could throw their cash at the cool, righteous companies and still make a pretty penny. But then, bam! A little virus coupled with big doses of science decided to crash the party, with the helicopter money and isolation beers followed by big chasers of austerity. Goodbye clean tech beach parties hello oil baron line dances!

Couple of years later and now guess who's hogging the spotlight on those performance charts? Yep, it's those big, boring cash-cow megacaps that every manager and their dog owns. And to make up for this, we've got engagement ramping up as if it’s some kind of moral offset. Never mind that overall emissions are still on the rise—fiduciaries still aren’t exactly getting pats on the back for saving the planet. No, they're getting high-fives for financial results, because, let’s face it, moral victories don’t pay the bills. And unfortunately, integrity isn’t something you can mark to market every day!

Enter The 4 Horsemen 

I met Tariq Fancy, who was then BlackRock’s CIO of Sustainable Investing, at a KPMG conference in Toronto in 2019. We were on a panel together, along with Som Seif, the CEO of Purpose Capital and a trailblazer in the world of ETFs. As someone who likes to dig into the nitty-gritty, I always find it fascinating to know the backgrounds of my fellow panelists. In this case, both Tariq and Som had impressive finance resumes—just not a whole lot to do with sustainability. But hey, who’s surprised? The industry was overflowing with newly minted sustainability “experts” popping up as fast as new products hit the market.

The vibe on these panels had definitely shifted since the pre-GFC days. No more wide-eyed idealists, heavy on passion but light on assets. And forget about the post-panel drinks and laughs. Now it was all serious faces and spreadsheet talk. So, of course, my panel buddies were brimming with confidence, proclaiming that their big data tricks would ‘solve’ all the ESG analysis problems and magically prove the performance. I’ve heard this song and dance for years: better data and tools will lead to better decisions.

Having bounced between the environmental industry and finance, I couldn’t help but roll my eyes a bit. Anyone who’s run a genuine sustainability strategy knows that trade-offs prioritizing process over chasing popular benchmarks are just another day at the office. Sure, better data is nice, but it’s not a magic wand that’s going to wave away the tug-of-war between legit exposure and performance. Plus, without mandatory verification, the messy reality of gathering environmental data is going to stick around like a bad smell.

After just a year or so on the job, Fancy threw in the towel at BlackRock and pivoted to throwing rocks³. His exposé is well-written and makes some solid points, and I’ll try to give you the gist in as few words as possible: Fancy argues that using an ESG lens for investments is dangerous because it distracts from the real change that needs to happen in the political arena. His take? Companies are just gonna do their thing - optimize profits, and it’s downright naive to think anything genuinely good is going to happen beyond that.

Fast forward to 2023, and I find myself on another panel, this time at a Scotia Bank Sustainable Finance conference, sharing the stage with another of the Horsemen, Aswath Damodaran. Now, I knew Professor Damodaran as the wizard of company valuation, but his credentials in sustainability? Wasn’t clear. Not that this minor detail would stop him from going on a full-blown tirade, covering everything from the impossible task of defining what counts as “good” to the supposed uselessness of ESG investing in making any real impact on social or environmental issues.

While I could nod along to his points about ESG criteria being oversold in valuation and performance—because, let’s be real, similar criticisms are applied to active management in general—there was nothing to back up his grand claims about the lack of progress. It's like saying, “I don’t see it, so it doesn’t exist,” without bothering to check if maybe you just need glasses.

Third in the apocalypse arena is Desiree Fixler, who famously blew the whistle on DWS’s rather creative interpretation of what AUM could be counted as ‘ESG’ - seemed more like ‘Everything Sounds Good’. This on point exposé has somehow morphed into a sweeping declaration that ESG is a complete ‘scam'. Somewhat of a shock to those of us who were running these strategies back when being ‘green’ was less of a virtue and more of a niche for people wearing Birkenstocks and hiking shorts. To work.

But let’s give credit where it’s due—her expose did shine a spotlight on marketing departments that had gone rogue, tossing around ESG buzzwords like confetti at a wedding. It was about time someone pointed out that slapping a green sticker on a financial product doesn’t make it environmentally friendly. Although it can seem redeeming, well, at least until your offices are raided.  

The fourth rider in the arena, and attempting the highest jump, is Stuart Kirk of the ‘HSBC PowerPoint Moment’ - a presentation that is probably not Nobel Peace Prize material like the Inconvenient Truth, but definitely has its charms. Kirk’s points about valuing climate risk are well-trodden ground, especially since Damodaran has already covered them extensively. But that’s not the fun part.  According to Kirk, climate change isn’t really something to fret over because humans can just adapt, and financial markets have absolutely nothing to worry about. Now, this would be an intriguing take if it came from an evolutionary biologist or a climate scientist who knows a thing or two about human adaptation over millennia. But from someone without that background? It’s a bit like handing out life advice based on a fortune cookie—vague at best and completely missing the point.

One soundbite in particular was a crowd pleaser: “Who cares if Miami is under 6 meters of water 100 years from now?” because, you know, Amsterdam is already below sea level and apparently doing just fine. I’m sure visions of the city’s lovely little canals popped into even the HSBC execs’ heads, until they did the math and realized that Amsterdam is only 2m under on average, so Miami at 6m does not bode well for either city. Oh, and Venice might as well be the next Atlantis, while cities like New York, London, and Shanghai could well, just buy all those gondolas. Oh, and too bad about all those lost lovely island nations. But hey, who’s counting meters? Clearly not Kirk. Couldn’t quite clear the minimum height.

If it Ain’t ‘Woke’ Don’t Fix It?

Beyond the obvious explosion of misguided ESG products and overzealous marketing, the popular critiques seem to completely miss the genuine improvements in corporate environmental performance and disclosures over the past 20 years. These changes are pretty hard to ignore, especially if you had the "pleasure" of working in or with industry before ESG became a buzzword. Back then, believing in progressive legislation meant relying on enforcement that was so rare, shop floor staff could time their emissions and discharges in offset rhythm to agency visits. They seemed to call first anyway.

Improvements in this approach didn’t just happen because governments politely asked or cleaned out the piggy bank for enforcement coin. No, they came about because investors started demanding it. And as companies began to shape up, governments found the courage to tighten regulations and make sweeping environmental commitments. It’s been a big mutual admiration society—everyone patting each other on the back for a job well done.

So, contrary to what some critics might say, the rise of ESG hasn't stalled necessary action; it’s actually done the opposite. Real emissions are lower than they would have been otherwise. Sure, they’re not as low as we’d all like, but they are lower. In the messy, divided world of mature democracies, governments usually only get moving when there’s solid support from businesses. And where does this support come from, if not from forward-thinking investors who push companies to consider more than just their next quarterly report? It’s not perfect, but it’s progress.

But let’s be honest—there are definitely limits to what ESG can accomplish. Shareholders, even the so-called "responsible" ones, aren’t exactly clamoring to support regulations that might shrink their profit margins. Just take a look at the Thames Water fiasco: when it came down to choosing between paying out dividends and investing in capital expenditures, guess which one got the green light? Spoiler alert: it wasn’t the one that involved spending money on infrastructure. It wasn’t until the government had to step in that anything changed—because, surprise, surprise, people actually need clean water and functioning wastewater services. And it’s not just investors who are reluctant—voters aren’t too keen on new taxes that might mess with their daily lives, spending habits, or savings accounts either.

In the critiques from financial experts, ESG research often gets brushed off as nothing more than a box-checking exercise. And why? Because, let’s face it, that’s exactly how most financial professionals treat it. They complain that ESG is too broad, open to interpretation, and hard to link directly to valuation or performance. And sure, these criticisms are pretty similar to those thrown at active management in general, so there’s probably some truth to them. But ignoring the impact that ESG has had on corporate behavior is a pretty big oversight. It’s like saying the only thing that matters is what’s on the balance sheet, while completely overlooking how companies are actually evolving and responding to new pressures.

Sure, plenty of companies play the ESG game just to score some good ratings and look shiny on paper. But let's not forget that there are also a lot of companies out there genuinely making strides, going above and beyond what regulations require. Ignoring how ESG has altered the corporate landscape for the better is like missing the talking Gorilla in the room. How are you not celebrating that?! Behavioral change has to start somewhere, and where better than at the epicenter of power: the modern corporation?

It has to start somewhere, it has to start sometime

What better place than here, what better time than now?

Rage Against the Machine 

Even when there’s clear progress in how companies operate, you’ll still hear people arguing that CEOs shouldn’t be deciding societal priorities. Ok, except we let CEOs make these decisions all the time. They decide which products get developed, how they’re priced, and who gets hired, all of which effectively shape how natural and economic resources are distributed. Not to mention, corporations play a massive role in lobbying governments to bend the rules in their favor, often exploiting different jurisdictions to maximize their advantages. When this occasionally happens in the open its usually in a pretty ski town like Davos but most of the time its still in the locker room or golf course. So, while critics may scoff at the idea of companies taking the lead on societal issues, in many ways, they’re already doing just that—whether we like it or not.

Take the oil and gas industry, for example. It’s no secret these guys have been working overtime to block environmental action—not just on carbon emissions but on sulfur and nitrous dioxides, methane, and every other discharge that comes out of a pipe.  And why wouldn’t they? With enforcement historically as underfunded as a high school bake sale, it’s often been open season. Acknowledging this doesn’t mean we’re ignoring that they provide something essential—it just means delivering that something should maybe, just maybe, reflect the costs to cover the real damage. Crazy idea, I know! But no crazier than expecting fair play in an industry where cartel pricing is doled out by an absolute monarchy.

But let’s not kid ourselves into thinking the oil and gas sector is a lone wolf here—we’ve been handing over decision-making power to corporations for decades without a second thought. Just look at the big pharma and food industries. Is there anything remotely sensible about using society’s resources to pay for medications that counteract the addictive effects of junk food? We really shouldn’t be so naive.

In future notes, we’ll explore how companies, from food to media, fine-tune their products to exploit human nature, whether it is taste, convenience, that warm fuzzy feeling of belonging, or the thrill of status. And they do this even when it leads to some pretty hefty social and environmental fallout. But hey, that’s business, and we’re just fiduciaries! What could possibly go wrong?

While the popular critiques conveniently gloss over this status quo, you’d think nudging the corporate social pendulum a bit in the opposite direction—cutting pollution, improving health outcomes, and ensuring livable wages—wouldn't be seen as the most radical challenge ever thrown at capitalism or democracy. In fact, it’s more like a necessary tweak to tackle some of the biggest systemic messes we’re dealing with.

Instead of wringing our hands over how ESG is "dangerous" because it supposedly gives social power to unelected managers—who, let’s be real, already wield that power—we might want to consider a different angle: that ESG is actually stalling a much-needed, deep rethinking of capitalism. Or at least what we might call ‘fundamentalist’ capitalism (to offset the every popular ‘woke’ version) but in this case where natural and economic resources magically align with the needs of a very select few.

If our current system is driving us toward greater inequality and an ecological dumpster fire, it’s a bit delusional to think that ESG—at least as a handy little add-on to makes financial pros feel better about themselves—is going to fix these systemic meltdowns. Let’s face it: it’s like trying to fix a broken leg with a band-aid. The real problems are far bigger than these feel-good, surface-level tweaks.

And Next Up…

In "Financing the Anthropocene," we’re trying to build a solid foundation for finding a real path forward. This means starting with the basics: understanding human nature, then figuring out what long-term sustainability actually looks like, and finally considering what role the financial and corporate sectors should play. Yep, its a odyssey, but doing it the other way around—by asking what the financial system needs first is, as I’ve noted before, like asking the wolves to guard the henhouse. It just mirrors the world as it is, not the one that has longevity.

Fancy, in particular, talks about the need for a response to climate change that’s as urgent and coordinated as the one we had for COVID. But to get there, we’d need one of two things: either the crisis becomes so apocalyptic that even the most stubborn heads come out of the sand, or society undergoes a major behavioral overhaul. Sure, that sounds about as likely as pigs flying right now, that’s where finance in the Anthropocene needs to be aiming.

We’re going to keep exploring all the behavioral quirks that help us ignore reality—like recency bias and the belief that humans are just too special to fail—which let us prioritize keeping the financial system happy over, you know, saving the planet. But let’s also think about how that system contributes to dulling the very adaptability that Kirk had so much faith in, and that got our species this far in the first place. It's unlikely that humans have ever ignored nature's signals to the extent we do today, so whatever incentives are out there making us turn a blind eye, they must be pretty darn irresistible. 

1. https://www.unepfi.org/industries/investment/the-materiality-of-social-environmental-and-corporate-governance-issues-to-equity-pricing/

2. https://documents1.worldbank.org/curated/en/280911488968799581/pdf/113237-WP-WhoCaresWins-2004.pdf?ref=journal.zarplata.ru

https://www.unpri.org/about-us/a-blueprint-for-responsible-investment

3. In 2023, Purpose Capital would be forced to retract some of its ESG claims as part of an industry wide crack down by Canadian securities regulators