From the desk of John Arnesen
Consulting Lead, Pierpoint Financial
As Roy mentioned in his blog last week, Pierpoint took August off posting blogs to coincide with the holiday period in the Northern hemisphere. That isn't to say there was a shortage of worthwhile news going on, from awful events in the central Asia to an extraordinary 18-year-old from my hometown area winning the Tennis US Open.
One consistent theme closer to home during the summer was the press coverage of ESG related news, some of it very critical of companies overstating their credentials and regulators starting to beef up their oversight. I read many ESG articles; we have blogged about it on several occasions, and the more I read, the more I find myself leaning towards scepticism. Not of the principles that ESG is attempting to address, but the creation of ESG funds and their credentials to absorb the headline record flow of money into them.
There was a couple of stories that really caught my eye recently.
One was the series of essays by Tariq Fancy, former Chief Sustainable Investment Officer at Blackrock, and the other was the execution of an ESG linked repo transaction between Deutsche Bank and Akbank.
Fancy's essays are of interest because of the position he held. It was the first role of its kind, but after two years, Fancy resigned, labelling ESG investing as a dangerous placebo. At the risk of butchering his overall message, I'll summarise as follows.
Claims made about the positive effects of ESG investing do little to address the long-term problems because the investment horizon of typical investors and institutions are not aligned with the complex timescale of the significant, collective issues. Promoting and packaging ESG funds to investors in the way they are, lulls them into a false sense of the impact that may be achieved better by taking practical action themselves.
He addresses that divestment from 'bad' companies and purchasing of ESG friendly investments may well drive down the price of the bad stock in the secondary market, but all that is achieved is the transfer of stock from one party to another that may well take advantage of higher returns as the price recovers. There is no real-world impact.
There are many more themes Fancy discussed in his essays, and I highly recommend them. Here is the link to the first essay, which links to subsequent essays.
Naturally, some commentators counter Fancy's arguments, but I found his writing compelling reading and the issues he raises definitely need more debate. What if he is right or even partially right? What if the best intentions fail to have any material impact on the severe issue they are trying to address?
I struggle with lumping E, S and G into an overarching title. Financial institutions' social and governance aspects are far more within their grasp to develop policies that deliver effective change and are likely easier to measure. The environmental aspects are arbitrary, incredibly complex, and requires a global approach from individuals to governments that perhaps the 'E' should stand alone. Should corporations, particularly financial institutions, shift their raison d’être from serving shareholders and extracting profit to some sort of social do-gooders and environmentalists held accountable for solutions to the world's thorniest issues? Is that what shareholders want?
I believe that the rush to claim ESG credentials runs the risk of sloppy or loose compliance or complete fabrication, which increases greenwashing accusations. It can happen across all products.
Innisfree, a South Korean cosmetic company, launched a plastic bottle covered in paper with the words 'This is a paper bottle' and defended their position by claiming it referred to the wrapper only. Yeah, right. Pantene has a shampoo range, 'grow strong' with images of plants on the bottle and the tag line 'inspired by nature' The shampoo is all chemical-based and contains minuscule natural ingredients. If you want to be inspired by nature, do the 'Tall Trees walk' in the New Forest in Hampshire.
Ikea is up to it too. A recent ad campaign, 'Fortune favours the frugal' aimed and avoiding waste from single-use products is a worthwhile pitch. At the same time, they have allegedly been caught logging protected old-growth trees. Santos, a gas supplier in Australia, is in hot water with The Australasian Centre for Corporate Responsibility for misleading statements about the environmental impact it made in its annual report.
I'm guessing that most readers are aware of the 'whistleblower' claims of the former global head of sustainability at DWS that the firm made misleading statements in its annual report. The case is under investigation in both the US and Germany, and potentially will bring clarity over what can and cannot be labelled ESG. As DWS has stated, they make clear distinctions between 'ESG integrated assets', in which sustainability considerations are part of the overall investment strategy and 'ESG assets', which are specialised vehicles to focus on sustainable investing. The outcome of the investigation should be a welcome clarifier as DWS will not be alone in this matter, and judging from the chart below, it is an industry-wide issue.
There are many examples of ESG funds holding energy stocks that many would deem to be significant contributors to CO2 emissions, as described in the chart below.
Is this acceptable? It depends on how much effort these vast companies are making in transitioning from fossil fuels to more sustainable energy products, and the interpretation of available data is subjective. A Dimensional Fund Advisor manager recently stated that care should be exercised when relying on ESG ratings alone, comparing them to opinions. Investors need to dig deeper into how the data points are constructed and weighted, and then measured.
The devil in this detail is vital to any industry and regulators who ultimately rely on a 'rating'. A correlation dispersion between different rating providers has numerous examples, which isn't helping investors getting their heads around the issue.
The Deutsche Bank (DB) 'green repo' transaction announcement was, at first reading, hard to digest. It wasn't clear from the first story I read what made this different until I read the story on Deutsche Bank's website. If I have understood this correctly, DB has reversed repo'd $300mm with Akbank, and the interest rate on the transaction is adjustable to DB's advantage if Akbank does not meet three criteria;
Akbank sourcing its electricity from renewable sources
No financing of new coal production.
I think I get it. It's an attempt to hold yourself accountable to your own set of standards, which is admirable on the face of it. However, there is some clarity required.
What is the repo rate penalty that Akbank will pay should they violate these terms? With rates as they are, it would have to be huge to feel any real pain. What is the duration of the trade? Stipulations 2 and 3 are perpetual in nature, so is this a very long-dated repo or a committed rollover structure? Does the collateral meet both Akbank and DB's ESG policies? Lastly, what can the proceeds of the repo be used for? Meeting the interest rate commitment is one thing, but would that not defeat the objective if the proceeds are used to do something 'less green'? Indeed, the use of proceeds is one of the fundamental qualifications in the Green Bond Principles as published by ICMA.
I have to say, point 2) made me think. Is Akbank, in its entirety, powered by renewable sources only? If not, how much and what is the minimum threshold required by DB? If so, that is a tremendous result. Will this become a standard for others to meet? Imagine this question appearing in an RFP (if it isn't already)?
Regarding the DB transaction, will, in the future, securities finance be required to justify the purpose of every trade, the forms of collateral received screened for its sustainability focus, the use of revenue generated, and even as an agent, what your beneficial owners do with the revenue? Are we heading there, and do we want to?
The recently announced collaboration of several securities finance-related trade bodies will certainly task themselves with addressing these issues, as will the Global Principles for Sustainable Securities Lending (Global PSSL). The more representation with regard to this topic, the better. ESG issues in securities finance go beyond collateral, tax policies, recalls, and identified more apparent issues.
An excellent webinar hosted by Minerva and Solactive may debate these issues further on Thursday, September 23rd 2021. Here is a link to this free-to-attend event: