Feeling good without doing good - the case of ESG and greenwashing

Ananth points to a recent tweet storm by Lyn Alden,

"ESG investing" in its current form is similar to people who take selfies of themselves in fancy locations to show they were there, while barely experiencing it for real. Mostly theater, little substance.

For example, we pollute, but buy offsets to make it someone else's problem. We outsource our manufacturing base to another country to reduce headline energy consumption, but then buy products they make while blaming them for polluting. This is deflection, not reform.

Software companies that build a business around addicting teens to their platform with regular dopamine hits & abuse user data sit atop the ESG investment indices, while fossil fuel producers that keep billions of people alive and comfortable are often excluded as a whole sector.

There's a trend to cut off existing energy production before having viable replacements. Solar and wind for example, are intermittent. They require grid-scale storage, which doesn't exist in cost-effective form yet. It requires massive copper/nickel/other-metals production. If you run the math on how much copper, nickel, and other metals the world needs to produce in order to reduce oil/gas/coal usage as a percentage of global energy production, it's far beyond what we can currently produce. And those metals require fossil fuels to dig up... We cut existing nuclear production and end up relying more on coal than we otherwise would have. We overbuild intermittent sources of power production, without proper storage, run into energy shortages, and then act surprised and resort to coal...

We rightly condemn human rights violations that China is doing to Uyghurs, but the biggest holding in Vanguard's ESG ETF is Apple, which signs quarter-trillion dollar deals with the CCP. So people sell their Chinese shares, buy Apple shares instead, and pat themselves on the back. Meanwhile their phone, computer, chair, sneakers, cookware, electronic devices, and kids' toys are all partly Chinese made. A lot of it is window dressing.

The bottom line is that ESG investing limits profits and creates winners and losers. In fact, there is only so much that can be done without reducing profits. And, therefore, only so much that can be achieved in mitigating climate change etc through market forces. 

Real-ESG investing is that which seeks to force businesses to internalise social and environmental costs and engage in more equitable sharing of returns with labour. The former would involve businesses seeking to mitigate the environmental and social consequences of their actions by establishing effluent and other pollution abatement mechanism, eschewing tax avoidance etc. The latter would involve revising the balance between capital and labour, and pruning down executive compensation and increasing the wages and benefits for their workers. Is it at all reasonable to imagine any of these steps being taken by businesses on their own volition? 

Globally the volume of assets under management in funds committed to the UN supported Principles for Responsible Investment, a proxy for ESG funds, amounts to $121 trillion. As the feel-good virtue signalling associated with ESG rises in importance and its volumes grow, the ESG market is naturally incentivised to undertake window-dressing (impact or green-washing) and sometimes, even outright fraud.

James Mackintosh has a series of articles in WSJ on the problems with ESG investing. He highlights the problems with the big three pro-ESG arguments,

First, if companies treat the environment, workers, suppliers and customers better, it will be better for business. This could work where companies have missed something to boost profits, such as add solar panels on a sunny roof or create a better employee retention program. Early ESG activists plucked the low-hanging fruit here, but management has become painfully aware of changing customer and employee expectations, so there is less opportunity ahead... The second ESG point is that by shunning stocks or bonds of dirty companies, and embracing those of clean companies, it will direct capital away from bad things and toward good ones. After all, a lower stock price or higher borrowing cost in the bond market should make it less attractive for dirty companies to expand, and vice versa for clean companies. In practice, there has been a very weak link between the cost of capital and overall corporate investment for at least a couple of decades. Small changes in the cost of capital pale in comparison to the risk and return projections of a new project... The third claim from some ESG investors is that they are just trying to make money, and that involves shunning firms that are taking unpriced risks with the environment, workers or customers. Since they call themselves “sustainable” or use “ESG integration,” funds doing this look very like the rest of the ESG industry.

He also points to four ways to cut fossil fuel usage - government action, shareholder pressure on fossil fuel companies, technological changes make fossil fuels more expensive, and people consume less of fossil fuels - and the challenges with them.

The four options laid out here lead to directly opposing approaches for investors who want to improve the world. The philanthropic approach means buying fossil fuel stocks to leave the carbon in the ground. The new technology approach means buying clean-energy startups to work on fusion, algae, cranes that store power, and the like. When the government gets involved, either with regulation (option one) or taxes (option four), investors should expect fossil reserves to be worth a lot less, perhaps zero.

This summary by Mackintosh is very apt,

My big concern about ESG investing is that it distracts everyone from the work that really needs to be done. Rather than vainly try to direct the flow of money to the right causes, it is simpler and far more effective to tax or regulate the things we as a society agree are bad and subsidize the things we think are good. The wonder of capitalism is that the money will then flow by itself. 

In other words, any meaningful solution to these problems have to involve at least some coercive element of regulation.  

In the context of ESG, last year, the US Securities and Exchange Commission had issued an ESG Alert. Some of its findings

This rapid growth in demand, increasing number of ESG products and services, and lack of standardized and precise ESG definitions present certain risks. For instance, the variability and imprecision of industry ESG definitions and terms can create confusion among investors if investment advisers and funds have not clearly and consistently articulated how they define ESG and how they use ESG-related terms, especially when offering products or services to retail investors... Portfolio management practices were inconsistent with disclosures about ESG approaches... Controls were inadequate to maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions... Proxy voting may have been inconsistent with advisers’ stated approaches... Unsubstantiated or otherwise potentially misleading claims regarding ESG approaches... Inadequate controls to ensure that ESG-related disclosures and marketing are consistent with the firm’s practices... Compliance programs did not adequately address relevant ESG issues.

Aswath Damodaran has several useful posts highlighting the folly of chasing the ESG dream. 

It's hard not to come away with the belief that ESG investing is a giant diversion from taking the required steps for making the economy more accountable (G), equitable (S) and sustainable (E).  

Update 1 (12.02.2022)

More reminder that green transition comes with a steep cost. This for a transition to more green shipping fuels like ammonia and methanol.