Financial investment with ESG criteria has entered a first phase of maturity in which some preconceived ideas about this type of investment are beginning to be questioned. The revaluation of companies understood to be associated with ESG objectives was spectacular during 2020 and 2021 thanks to the rotation of money under management toward these companies. There was a feeling that investors could save the world.
After the ‘fever’ for these funds in 2020 and 2021, ESG investing is going through turbulent times in 2022. According to Morningstar, in the first quarter of 2022 sustainable funds had their first drawdowns in two years.
Comparing the increase in global emissions with the increase in sustainable funds in recent years, it seems investors are not heading in the right direction. Last year marked a record high for CO2 emissions, according to the International Energy Agency.
One of the sectors with the best evolution in 2022 is the oil companies. In 2022, Repsol has the second-highest revaluation of the IBEX 35 while Exxon, one of the largest oil companies in the world, is close to 70 percent up. The results published as of June 2022 by these companies have set records, supported by the price of energy.
This contradiction occurs elsewhere, too. Tesla, a pioneer in the manufacture of electric cars and perhaps the company that best represents the idea of mobility without fossil fuels, has been excluded from the S&P 500 ESG index. Its CEO, Elon Musk, has declared that sustainability is a scam.
At the end of May, German police raided the offices of investment fund manager DWS in search of evidence of greenwashing (claiming to meet ESG criteria in the marketing of its funds without meeting them). The fund manager is controlled by Deutsche Bank and manages investments of more than €900 bn ($3.7 bn). The CEO of DWS resigned from his post, while the bank’s shares fell by as much as 8 percent on hearing the news.
The SEC has confirmed that it is investigating ESG funds marketed by Goldman Sachs. This has raised reasonable doubts about the extent to which fund managers stretch the ESG criteria for the funds they market to be classified as such.
If we add to these doubts poor profitability once funds have stopped coming in due to the simple rotation of assets, investment with ESG criteria runs the risk of becoming just another financial product, susceptible to being invested in or not solely on the basis of its financial profitability and ability to generate commissions.
If we move from ESG as a financial investment to ‘official’ ESG, we also see important changes. The EU, which represents 22 percent of the world’s GDP and around 10 percent of global emissions, decided to take the political lead in promoting sustainable investment. The EU’s new Corporate Sustainability Reporting Directive (CSRD) is being drafted with the aim of bringing non-financial information closer to some of the requirements for financial reporting. The draft directive estimates that the costs for companies could reach €3.6 bn per year. The number of companies affected by these new obligations will increase from the current 12,000 to around 50,000.
With these impacts, it is understandable that the CEO of one of the main European financial institutions declared that banks cannot be the policemen of the world, in reference to the enormous amount of information they are asked to provide in relation to the risks associated with ESG, its impact on costs and the resources needed to prepare it. In addition, companies need to be managed.
‘Industrial ESG’ needed
Buying and selling shares and increased reporting alone will not stop climate change. What’s needed is industrial ESG: investments in the real economy that require regulatory certainty and stability before they can be undertaken. Companies can sometimes take advantage of stock market booms – Tesla’s sharp rise allowed it to raise capital and finance its factories, for example – but many small and medium-sized companies do not have easy access to capital markets.
In this transition, the political agenda of governments and their ideological position has a huge influence. The share price of a company can be greatly affected. Many energy transition projects in their current phase are not economically viable and companies undertake them seeking investor approval for their stock price, but their bottom line and free cash flow generation will suffer for years. Accelerated closure of industries deemed ‘unsustainable’ can also have high social costs and significant stock market declines for these companies.
Stock market appreciation, social welfare and environmental protection are objectives that are difficult to balance. If too much emphasis is placed on one of them, the consequences are unpredictable, even in wealthy areas like Europe. It should not be forgotten that it is the citizens and shareholders of many companies who find themselves in the middle of this unstable triangle of equilibrium.
Ricardo Jiménez is the former IR director of Ferrovial