There’s been a lot of encouraging news over the past year related to environmental, social and governance metrics — ESG, for short — and sustainable finance: the meteoric growth of ESG-themed investment funds, a similar trajectory for ESG-rated loans and bonds, the coming consolidation of ESG rating and reporting systems, the linkages between high ESG scores and corporate financial performance, and more.
It’s easy to look at all this with optimism that Wall Street and its brethren around the world are finally recognizing the perils and promise of a global economy impacted by a changing climate, biodiversity loss, social upheaval, economic inequality and other pressing social and environmental issues. And that investors will hold companies accountable to reduce their impacts and, in the process, their risks, while providing capital and leadership for a “just transition” to a kinder, gentler world.
Ah, the delicious fantasy of it all!
It’s easy to look at all this with optimism. The reality is far different.
The reality is far different. For all the salutary change it may be creating in financial circles, the ESG landscape remains treacherous and unforgiving. Corporate ESG data continues to be uneven and incomplete, often lacking consistency across companies, sectors and borders. Companies are disclosing some types of risks but not others. Banks are failing to align their public commitments with their on-the-ground practices — for example, falling short on managing the climate risks of their corporate and institutional customers or continuing to fund fossil-fuel development. There remains a stubborn disconnect between investors’ needs for relevant ESG data and what companies are disclosing. The word “greenwashing” is being applied willy-nilly to just about any activity or claim that doesn’t look kosher to someone or another.
Moreover, the whole topic of sustainability and climate change is being viewed as a wedge issue in the United States during the upcoming 2022 and 2024 election cycles, with the right wing pushing back on the left for its “radical” policies. This could, at best, retard the pace of change. At worst, it could bring whatever progress exists to a screeching halt.
ESG and sustainable finance have long been, and remain, the Wild West, filled with myriad gunslinging parties staking their claim, often duking it out with competitors and critics, without any sense of who’s truly in charge — or even who the “good guys” are.
Welcome to ESG, 2022 Edition.
As I said, on its face, ESG and sustainable finance seem to be moving in the right direction, and at a pretty good clip. Money is pouring into ESG funds by the tens of billions per quarter, double the rate of just a year ago. Green bonds are being issued at an impressive rate, many oversubscribed by five or 10 times. In the run-up to COP26, an astonishing array of public- and private-sector entities and financial institutions made significant commitments, some in the trillions of dollars, as I recently reported.
But the post-COP reports paint a far more concerning picture. A sampling:
- A new report from the International Organization of Securities Commissions (IOSCO), a global group of regulators, cited a lack of clarity and standards in ESG metrics, a lack of transparency about the methodologies underpinning ratings, and uneven coverage of sectors and geographies. It called for greater oversight of ESG ratings and data providers.
- A new survey by Macquarie Asset Management found climate change is considered a priority ESG issue for institutional investors, but most face challenges integrating the consideration of climate risks into their investment portfolios. While more than half of investors identified climate change as their primary ESG concern, less than half track some or all of their portfolio emissions or address physical and transition climate risks.
- A report from the European Central Bank about the management of climate and environmental risks by the European banking sector found most commercial banks it supervises don’t have concrete plans to start preparing for climate change, a situation no doubt similar in the rest of the world.
- Moody’s reported that financial institutions in G20 countries have $22 trillion of exposure to carbon-intensive industries — roughly 20 percent of their total loans and investments. This could set them up for a fall should some of these companies and sectors sharply decline or are saddled with costly stranded assets.
- The idea that sustainability-linked finance would reward proactive companies and penalize those that don’t achieve their goals doesn’t really hold water, according to a Bloomberg analysis. It looked at more than 70 sustainability-linked credit lines and term loans arranged in the United States since 2018 and found more than a quarter contain no penalty for underachieving their stated goals and enjoy only a minuscule discount if they meet them.
Call it growing pains, perhaps, but they’re not without consequences. There’s a real risk here of failing to meet the relatively modest goals banks and investors have set for themselves while, perhaps, drawing fire from both the political left and right. And with the clock ticking, there’s little time for a reboot.
The bottom line: There’s a lot that needs to be fixed and accelerated, and quickly. The amount of capital needed to simultaneously fund rapid decarbonization would be staggering even if a lot of the challenges above didn’t exist.
But who will fix things? National leaders are historically loath to challenge banks and insurers. The regulatory agencies that comprise IOSCO will likely plod along at the slow pace it typically takes to propose, enact and enforce new laws. Activists will continue to shine a light on what’s broken or what could work better.
That leaves the private sector — asset owners and managers, corporate and institutional borrowers and bond issuers, investors and stock exchanges — as well as NGOs and business groups to step in with aggressive action.
Can they do it? Will they? How on earth will financial institutions balance self-interest and that of investors with the needs of billions of humans?
If money does indeed talk, it’s screaming for help right now.
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