Is ESG a Proxy for Sound Risk Oversight?
Capital Markets Supply-Demand Perspective
Greenwashing is prevalent in corporate practices. The reasons are simple: profits. Research demonstrates that products with sustainable claims sell faster than similar products without such claims. Consumers demand sustainable products and are willing to pay premiums of up to 30% for such offerings. In the beverage industry, for example, the brands labeled as “sustainable” are the only growing categories. Street-smart marketers take advantage with creative shortcuts. Welcome to greenwashing in consumer markets!
As markets mature and consumers are becoming more sophisticated, stronger scrutiny is being placed on such claims, either in the name of consumer protection, fair competition, or transparency. If ESG is to be a proxy for sound risk oversight, one would expect that capital markets, in the attempt to price risk correctly, would demand more scrutiny and transparency from their investment targets. Do they?
Capital markets are critical to the economy and they are critical segments of the economy subject to basic economic principles such as supply and demand, or reward effects.
Unprecedented growth of ESG investing demonstrates investors’ growing sentiments towards a “doing well while doing good” philosophy. In practice, this translates into increasing demand for the right investment targets: ESG-minded companies. To satisfy this demand, investment managers, incentivized (heavily) to capture new capital, create products and services labeled as “green,” “ESG,” “SDG,” “sustainable,” or “responsible.” However, when looking under the hood, one may be surprised to find that her supposedly green portfolio includes a top polluter, and her socially responsible fund includes a company with prison labor in the supply chain. Why? To boost profits and the commissions of investment managers, as truly green companies that make significant investments into transitioning into a clean economy cannot match short returns of polluters. Welcome to greenwashing in capital markets! (1)
So, is ESG a proxy for sound risk oversight?
Well, it could be. First, we must eliminate greenwashing from capital markets.
This is not a trivial task. It requires systemic clean up, which,🤞, has already started. In early March this year (2021), the SEC announced a Climate and ESG Task Force to “proactively identify ESG-related misconduct.”
With a quarter of AUM globally being labeled as “green,” “ESG,” “responsible,” or “sustainable,” one hopes that responsible capital will move humanity towards the brighter future with ESG as a North Star. It appears though that the invisible hand of capital markets needs some corrective guidance to stay on course.
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(1) “Financial World Greenwashing the Public with Deadly Destruction in Sustainable Investing Practices” by Tariq Fancy, a former Chief Investment Officer of Sustainable Investing at BlackRock; USA Today; March 16th, 2021
