Is ESG Over? Stephen Kitching

“We’ve had a question from a senior member of staff: Do our investments align with ESG principles?”

“Which ESG principles?”

“Ours, presumably”

“What are our ESG principles?”

“I don’t know. What is everyone else doing?”

This conversation or similar has been repeated in treasury departments for the past 10 years. Unfortunately, the focus has generally been on what others are doing, rather than what each organisation’s principles are. The desire to demonstrate that investments are “ESG” with the minimum of fuss has created an industry that aims to ensure that organisations are investing in a way that aligns with positive Environmental, Social and Governance ideals.

ESG Funds, ESG Investment Ratings, even ESG reports! But they all assume that “ESG principles” are a single thing we all agree on. You can even be sacked for questioning the consensus.

However, the days of outsourcing our morals may be coming to an end.

Excluding arms manufacturers is something 99% of ESG funds will proudly state in their investment prospectus, and it has remained unquestioned for over a decade; investing in weapons is bad, everyone knows that!

Then the invasion of Ukraine happened.

Putin’s invasion has led to a fundamental rethink of the morality of investing in Western arms companies. If you’re a local council and you are trying to reflect the principles of your residents, then you will struggle to find a more popular view than sending military aid to Ukraine.

I hope it isn’t too obvious but to send military aid, you need arms companies which produce weapons.

If your ESG policy currently excludes arms manufacturers, can you honestly say that it reflects your principles? A local authority which has passed a motion supporting military aid to Ukraine, but withholds its capital from the company which produces the NLAW, doesn’t have ESG investment principles, it has someone else’s investment principles.

This isn’t theoretical, Sweden’s SE Bank has changed its investment criteria explicitly in response to the war, allowing its ethical funds to invest in western weapons companies. I’m sure there’s a “no atheists in foxholes” joke here somewhere.  

Ah, but we can all agree on climate change, no more fossil fuels! Actually no. For example, Poland has an ambitious target to transition to net zero and is replacing polluting forms of energy with those that don’t produce greenhouse gases. However, during the transition, Poland intends on burning coal. Lots and lots of coal. 5 years ago, people would have laughed if you had called coal a transitionary fuel. Those same people are no longer laughing.

This is without the question marks around the environmental credentials of some popular renewables.

So, is ESG dead? No, and in fact ESG considerations are more current than ever. What is on the way out is the idea that a public sector organisation can sign up to some generic ESG principles, stick its money in a fund that is labelled as ESG and forget all about it.

From now on, authorities will need to start from the beginning; what are our principles? Only once an organisation has really identified what it wants to stand for can the treasury department put those principles into practice.

In conclusion, all of this is a good thing. ESG investing is moving from an early phase into something more sophisticated where investors will be challenged to really interrogate what they believe, rather than undertaking a tick box exercise. We can all welcome that.

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