ESG Investing: Capitalism’s Answer to Climate Change and its Failures

Words by Rose Jones

Capitalism has long been recognised as a driving force of global climate change and inequality. Historically, the most profitable decisions are those that are socially exploitative or impose harm to our natural environment, through increased consumption of natural resources, pollution, and destruction of biodiversity. Thus, company executives often refrain from making environmentally and socially conscious decisions, in favour of greater profit. As such, in order to avoid climate catastrophe, economists agree that there needs to be some form of global market transformation.  

One such strategy to encourage market reform is the ESG framework, introduced in 2004. The ESG framework allows prospective investors to better understand whether businesses are behaving in a socially responsible way, based on their performance against a set of Environmental, Social, and Governance criteria. In theory, the ESG framework allows socially conscious investors to screen their investments, based on corporate policies on issues of climate change, social relationships and executive leadership, in a pledge to “do well, by doing good”. ESG investing has become increasingly mainstream in recent years, with giants of investment management claiming that more than $35 trillion in investments are monitored through the ESG framework. However, the question remains: “can profit-seeking firms really save the planet?”. Or as Tariq Fancy, previous head of sustainable investing at Blackrock, suggests, is ESG investing merely a fantasy that climate change can be tackled through businesses’ voluntary commitments to environmental issues, acting as a distraction from opportunity for real change through decisive government action?  

Unfortunately, ESG has come under increased scrutiny in recent years, despite its well-meaning origins. The framework suffers from three fundamental problems. Firstly, it operates using a single metric based on three very different, and often conflicting, objectives. Tesla, for example, has been instrumental in advancing electrification in the automotive industry thereby helping to tackle climate change, but performs poorly against the social and governance criteria of the ESG framework. As a result, it was removed from the S&P Dow Jones Indicies’ ESG fund, whilst ExxonMobil was added. This motivated Elon Musk to tweet “ESG is a scam. It has been weaponized by phony social justice warriors”. Without addressing these conflicts, ESG runs the risk of deceiving investors through “greenwashing”.  

Moreover, the ESG framework relies on the theory that a good rating will be good for business performance and investment returns. This, however, is not always the case, as companies are able to endure stigma and opt for more profitable, irresponsible actions. As such, there is limited evidence that the link between virtue and financial performance really plays out. Disclosure of environmental, social and governance impacts are not enough. Rather, systemic reforms led by government are required to enforce real change. For example, a carbon tax and other regulations will result in a relative advantage to higher ESG performers, incentivising industry-wide change.  

Finally, ESG measurements across rating agencies are wildly inconsistent. ESG rating agencies often rely on out-of-date figures, disagree on standards and whether non-disclosure should be penalised. As such, firms are able to improve their ESG scores by simply selling assets to different owners and continuing to operate as normal. If ESG scores become more accurate and correlated, fund managers will struggle to engage in this form of “greenwashing” and will be more inclined to engage in real, positive change. If ESG scores do not become more accurate and correlated, they run the danger of becoming entirely meaningless.