Harry Geels: Suddenly the ESG concept is subject of serious discussion

August 15, 2023

^{This column was originally written in Dutch. This is an English translation.}

By Harry Geels

In the past two weeks, things suddenly went wrong for ESG scores. Rating agency S&P and McDonald's are going to stop measuring them. New scientific research showed that better-performing ESG companies emit just as much CO₂ as less-performing ones. And BlackRock's CEO prefers the term 'conscientious capitalism' on closer inspection. What now?

If we could name just one trend from the investment industry over the last decade, it would undoubtedly be ESG investing. According to a PwC report released late last year, ESG-oriented investments in terms of Assets Under Management (AUM) would more than double in the US to $10.5 trillion, rise to 53% of the total (to $ 19.6 trillion) in Europe and triple in Asia-Pacific to $3.3 trillion by 2026, according to Forbes. ESG increasingly became a hygiene factor: the asset manager who did not incorporate it into the investment policy was wrong.

As it so often happens with trends, things can suddenly go wrong. Let's first discuss three recent developments, then look at two broader, long-running discussions, and finally try to answer the question of what the future of ESG might look like.

S&P no longer issues ESG ratings

The rating agency S&P will no longer give debt issuers an ESG score of 1 to 5, citing growing questions about usability and political attacks on its use. According to the Financial Times (FT) S&P believes that only a qualitative judgment ('narrative paragraphs'), and not a quantitative score, does justice to a company's sustainable profile. A study initiated by Republicans into the scoring method was underway, which is important for companies because it partly determines their borrowing costs.

McDonald’s silently removed ESG from it's website

McDonald’s recently removed the ESG section from its corporate website. The 'ESG Approach & Progress' web page is now titled 'Our Approach & Progress', and 'Performance & ESG Reporting' now appears as 'Goal Performance & Reporting'. In some cases, McDonald's has replaced the abbreviation ESG with 'environmental and social issues'. The fast food group says it is 'cooperating with key stakeholder groups on environmental and social issues where it can make the greatest impact against the backdrop of an ever-changing external landscape'.

Research: High-scoring ESG companies pollute just as much as low-scoring ones

According to research by Scientific Beta, it doesn't matter in terms of CO² emissions whether a company has a high or a low ESG score, even if only the E-score is considered. 25 data providers of ESG data were involved in the study. Commenting on this research, an MSCI ESG Research spokesperson said that the ratings are 'fundamentally designed to measure a company's resilience to financially material environmental, social and governance risks and not to measure a company's impact on climate change'.

Rise of SDG investing

Investors are also increasingly looking at the seventeen Sustainable Development Goals (SDGs) that the UN developed in 2015. The portfolios must increasingly make a measurable contribution to at least part of the SDGs. It may well be that pursuing SDG goals is not in line with ESG policy. For example, there may be companies that have high ESG scores, but do not contribute to, for example, the most important SDG of the moment, number 7 'affordable and clean energy'. SDG also has a definition problem.

Longer-running discussions about ESG

Discussions about ESG have of course been going on for some time. For example, BlackRock's former Head of Sustainability Tariq Fancy left the world's largest asset manager after calling ESG a 'dangerous placebo', because it is 'subjective, works with unreliable data, encourages greenwashing and, above all, generates higher fees for investing clients'. SEC commissioner Hester Pierce added to that list: the danger of static definitions (can even work against climate transitions) and the promotion of herd behavior and inefficient pricing.

There have been more discussions. Recently, BlackRock's CEO Larry Fink preferred not to speak of ESG anymore, because it is politically ‘weaponized’. Other critics have called ESG a 'social credit system' similar to China's. Many of these critical discussions have so far failed to prevent the rise of ESG investing. They could still be dismissed as rearguard actions. But now that S&P and McDonald's have probably abandoned the concept (quantitatively), or at least are going to interpret it differently, there is seriously more going on.

What now?

Many fund managers have told me in interviews that they have been using ESG factors in their analysis for years. After all, a good analyst cannot do without an assessment of the company's climate, social and governance risks. Sometimes even the saying 'old wine in new bottles' fell. Although there is still a lot of political weight in the ESG concept, it is possible that the terminology will change and become a 'standard part' of the analysis again. The focus may shift to the new trend: the SDGs. And then let's hope that SDG washing doesn't become a big thing.

This article contains a personal opinion of Harry Geels

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