ESG Whiplash
Recent filings by a dozen big US financial companies, including BlackRock, Blackstone, KKR and others, included concerns that “divergent views” and “competing demands” on environmental, social and governance (ESG) investing could hurt financial performance. These statements reflect the growing attention given to a campaign against what critics refer to as "woke capitalism." The campaign aims to challenge and push back against the principles and practices associated with ESG investing. Presidential hopeful Ron DeSantis led a resolution to stop Florida’s state pension funds from considering ESG principles to guide investment and BlackRock lost a $2bn mandate to manage Florida Treasury funds as a result of its "woke capitalism."
BlackRock is arguably the best example of the complexity of taking a stand on ESG. As one of the most outspoken managers about the need to consider climate change in investing decisions under chief executive Larry Fink, when FOX Business presenter Charlie Gasparino asked Fink if the term "ESG" is now safe to utter, Fink remarked, "I don't say [it] anymore." At a recent BlackRock shareholders annual meeting, a resolution raising climate concerns won less than 10% support. One of the climate resolutions asked BlackRock to report on how it could improve pension fund client returns by focusing its stewardship efforts and proxy voting to "engineer decarbonization in the real economy." Fink said that is not their role. "We have clients who wish for that, but we also have clients who are not interested in that, and our job is to be working with our clients," he said during the meeting.
The controversy over whether managers should incorporate environmental objectives in their stewardship role and whether those environmental concerns are legitimate is compounded by the fact that there is no universal, objective, rigorous framework for defining ESG. A debate also rages about whether engagement or divestiture is the best way to clean up “dirty” companies. This has already led to the notable U-turn on the social utility of armaments post the Ukraine invasion and the awkward claim by the Chief Executive of Philip Morris that the stock is on the path to becoming an ESG stock. There is also a certain irony that it is Norway’s $1.4tn oil fund leading the way on the use of shareholder proposals to send messages on environmental, social and governance topics to US companies.
The realities of trying to achieve net zero are also sinking in. In the company’s 2022 ESG report, dubbed its Comfort Report, Crocs, the fashion faux-pas footwear company, said had planned to achieve this goal by 2030, but now expects to become net zero by 2040 only. “We’ve learned a lot in the past year. In 2021, we made a public commitment to be net zero by 2030. We stated this goal knowing it was ambitious, necessary and frankly, neither vast nor fast enough... The picture is now much clearer and we are working toward a new enterprise goal.”
Nick Leslau is despairing of the ESG agenda and thinks that “European economies are flatlining because we are regulating ourselves into oblivion. There is so much in the annual report now that I don’t even understand. The corporate governance section alone is longer than the whole annual report was at Burford. I am all in favour of saving the planet but ESG is an industry of entirely non-productive work — investment managers have entire divisions reading that crap!” PwC find that in Private Equity there is less demand for this ‘crap’: specifically, when asked whether quality ESG reporting is an important determinant in their GP selection process, 61.7% of PE-focussed LPs responded in the affirmative. While this percentage is by no means insignificant, it fell significantly below the global average of 80.2% reported by LPs in real estate, private debt, and infrastructure. Real estate is at the forefront of environmental considerations “given the tangible and high-impact nature of real estate assets and their vulnerability to climate-related risks”. PwC find that the “institutionalisation and codification of ESG” in real estate “is not yet mirrored by other asset classes. Further they find that “increased awareness of the inherent link between sustainability and real estate, coupled with intensive scrutiny from policyholders and industry organisations, has made the provision of accurate and impartial ESG data a critical concern for real estate investors’ survival. This is attested to by the sheer volume of real estate investors that select the GPs they work with based on their ESG reporting practices…S respondents are displaying by far the greatest affinity, with 96% of the country’s LPs viewing the provision of quality ESG reporting as an important determinant of their GP selection process.”
Banks are also increasingly prioritizing sustainability credentials, scrutinizing business plans to ensure the necessary investments to upgrade assets in alignment with sustainability goals. Meeting these requirements has become essential for securing financing from banks. In a report, CBRE find that non-bank lenders are also affected, as most debt funds raise funds from third party investors, such as insurance companies and pension funds. One of the first questions these lenders are asked by their investors is “what is your ESG and Sustainability policy?” Even if there is a current overlay of concern about inflation and interest rates, the ESG question is still present.
In the face of rising geopolitical and macroeconomic concerns, John Pattar, Asia head of real estate at private equity giant KKR, acknowledged that ESG “might drop down the list of importance” although regulation is likely to continue to keep ESG on the agenda at least for the Europeans, with both the EU Taxonomy Regulation and the Sustainable Finance Disclosure Regulation having gone into effect over the past few years.
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The inclusion of ESG language in financial companies' filings demonstrates a recognition of the concerns surrounding sustainable investing and the potential implications for their bottom line. It underscores the need to navigate the evolving landscape of public opinion and political discourse surrounding ESG principles, as well as the financial implications associated with such developments.
Fundamentally the language and the metrics needs to align a problem with a solution. Top Gear’s Chris Harris rails against the dangers of meaningless terms, comparing the use of the label “zero emission vehicles” to Japanese knotweed. He suggests that the process of making a car battery is environmentally ruinous and that the car industry is giving itself “worrying leeway” when describing new technologies.
Articulating the problem, as Harris illustrated above, is where much of “the divergent views” stems from. Even the BBC Academy defines “due accuracy” in journalistic reporting nebulously, where accuracy isn't the same as truth. It's possible to give an entirely accurate account of an untruthful fact. Indeed, something so trivial as the height of Mount Everest is actually heavily debated between the Indians, Chinese, Italians and others. The exact figure and its true size are dependent on a variety of factors including snow level, gravity deviation, light refraction and so on, so when a reporter is cavalierly quoting a ‘climate fact’, it could represent just one opinion. Alan Rusbridger, former editor in chief of Guardian News in his book ‘What to believe in a Fake News World’ points to journalistic failures in reporting, claiming “much editorial content was stupid, corrupt, ignorant, aggressive, bullying, lazy and malign, which makes it hard for the public to distinguish the good from the bad.” Even the British press regulator, the Independent Press Standards Organisation [IPSO], struggle to determine the accuracy of competing claims about global warming. They do not have the expertise in-house to make judgments about the science, and therefore following complaints considers the process of checking or verification that was undertaken in advance of publication, not contestation of the facts. Worse, in the US, there is no independent regulatory body that exists for print, accuracy is not a prerequisite for reporting.
The weaponization and wokeness associated to climate change can be potentially solved when its economic impact is taken into consideration. Mark Carney in his book “Value(s)” is arguably one of the most vocal public authorities on climate action, currently the UN Special Envoy for Climate Action and Finance. He argues that climate change is the ultimate betrayal of intergenerational equity. It imposes costs on future generations that the current generation has no direct incentives to fix. He uses this example: compare the valuations of Amazon and the Amazon region. Amazon's $1.5 trillion equity valuation reflects the market's judgement that the company will be very profitable for a very long time. In contrast, it is only once the Amazon rainforest is cleared that the land begins to have any market value at all.
In recent years there's been a 70% decline in the population of mammals, birds, fish, reptiles and amphibians. What would have been biblical, is becoming commonplace and arguably because they can't be financially valued. Net Zero isn't a slogan, it's an imperative of climate physics. Industrial processes comprise 32% of current emissions, buildings contribute 18%. Cities occupy 3% of the earth's land mass but account for 70% of CO2 emissions. Bill Gates in his book “How to Solve the Climate Crisis” details the key technologies we need to get to net zero, and focus as much attention on the political as the economic and technological challenges to get there. Carney’s argument is that if you align financial values with social values it can affect greater change, and quicker.
The costs and opportunities of the transition are becoming apparent, and the longer meaningful adjustments is delayed, the more transition risk will increase. When Carney first mentioned the prospect of ‘stranded assets’ in a speech in 2015 it was “met with howls of outrage from the industry”. We in the real estate industry solipsistically tend to think stranded assets are limited to office buildings that do not have an obvious pathway to EPC acceptability. However stranded assets are not limited to real estate. The EU estimate that up to €240 billion of assets in the European automotive industry is at risk of being stranded due to three potential disruptions: electric vehicles, driverless vehicles and car-sharing services, and central banks are increasingly focused on how potential risks to financial stability can be managed against the possibility that climate policy could be tightened considerably and suddenly.
Carney quotes Mark Moody-Stuart, then chair of Shell who acknowledged uncertainties around the predictions of climate science, but observed that there was over 75% likelihood the risks were at least as great. He then commented, that over his career in business he had frequently made multi-billion-dollar decisions with much lower odds, and that given the risks were existential, the value of acting immediately was clear.
Climate change, like pandemics, is a global problem. It requires global resources using the same language, which we believe is the language of money. The longer we defer crucial environmental upgrades, the costlier it will get. However, failure of governance, the “G” in ESG, is regrettably overlooked too. Duncan Sankey of Cheyne Capital argued that failures of governance were central to the demise of SVB, as short-term annual cash incentives for the C-suite were geared wholly to return on equity (ROE), so SVB’s management “reached for the stars.” Before we get distracted by the Billionaire class fixation on transportation to the constellations or the depths of the earth, let’s try to avoid World War Zero.?