WHEN COVID-19 began to tear through countries, politicians and business leaders largely followed the advice of experts and accepted swift government action to flatten the curve of infections. So why do so many of them still cling to the hope that firms and the market, left to their own logic, can flatten the curve of carbon emissions?
The Economist today
Handpicked stories, in your inbox
A daily newsletter with the best of our journalism
Perhaps the inconsistency is because commercial incentives are skewed to the short term. That science calls for flattening a curve isn’t enough to spark action if there is a long “incubation period”—that is, a delay before the suffering is fully felt. What epidemiologists advocated was costly and hard. So too, what climate scientists and economists recommend is expensive and difficult. Yet an inconvenient truth can give rise to a convenient fantasy: that society can achieve net-zero carbon emissions primarily through businesses’ long-term, voluntary commitments and the market functioning efficiently.
Before our collective memories of the pandemic fade, we have an opportunity to learn from it—and apply its lessons to climate change. With decisive government action of the sort used in the pandemic, the private sector can be harnessed productively.
However, the very group that should be at the vanguard—the environmental, social and corporate governance (ESG) community—hurts rather than helps. Yes, it usefully collects data and reports standards. And it encourages a wave of talented people to work in the area. But these technical and human resources are not used well. The result is that corporate ESG efforts have negligible impact. Worse, its saintly narratives distract the public from seeing the need for aggressive, systemic reforms that only governments have the ability and legitimacy to pursue.
I saw this firsthand in my role as BlackRock’s chief investment officer for sustainable investing from 2018 to 2019, based in New York. We, along with virtually every other large asset manager, eagerly engaged in a form of financial virtue-signalling that has become de rigueur in the industry, exaggerating how beneficial ESG information had suddenly become to all our investment processes.
Time and time again I was asked by clients how ESG investing mitigates climate change and to expand on the CEO’s annual letter to investors, which spoke in uplifting tones about the need for environmental capitalism. (At the COP26 conference in Glasgow this week, the chief executive, Larry Fink, was again reassuring. “The pathway is not going to be from brown to green,” he said, but a much more gradual process with fossil-fuel companies.)
From my desk overlooking the city on the 22nd floor of BlackRock’s midtown Manhattan headquarters, I spent months working on a white paper that attempted to draw out the case for ESG investing to fix the climate crisis. And then one day it dawned on me: I had just written a tortured argument that the market will somehow self-correct—to address the greatest market-failure in history.
The green-investing conundrum
The ESG community of which I was part—business people aiming to apply the logic of capitalism to support social goals—is focused on engaging with management to uphold environmental policies. Fighting proxy battles with irresponsible companies might work in areas where management refuses sustainability-related changes that are in the long-term interests of shareholders. But it doesn’t make sense for companies whose actual business model harms society, such as an oil company.
And the market “sanction”, divesting the shares of fossil-fuel companies, does not lower emissions; playing whack-a-mole against trillions of dollars sloshing around global financial markets is not a solution. It wouldn’t accomplish more than a tiny fraction of the change at the speed and scale that’s needed. Only in a distorted vision of economics, where the market is seen to solve all problems, are engagement and divestment the only options.
By way of example, consider cigarettes. The answer to revelations that smoking causes cancer was not proxy fights against individual tobacco companies to convince each of them to be more responsible and to voluntarily sell fewer cigarettes. It was government regulation that restricted what was deemed to be a harmful activity.
The ESG story is sold as an opiate to the masses. It lulls everyone from investors to activists into believing that more responsible companies also consistently perform better financially. In practice, ESG information has limited use in most investment processes. This is due to a combination of ambiguous data and inconsistent standards, short time-horizons for most investment strategies and the uncomfortable reality that being responsible usually isn’t profitable. The recent Facebook whistleblower’s revelations that the company optimises for profits over public safety should surprise no one at this point. Nor should it surprise anyone that this is what I saw at a systemic level, trying to integrate ESG goals into BlackRock’s trillions of dollars of capital, the largest pool of investor assets in the global economy.
Unfortunately, the utopian storyline around ESG actually undermines the case for government to play a role. Misleading public-relations activities foist the idea that sustainable investing, stakeholder capitalism and voluntary compliance are the answers. Whether “greenwashing” or “greenwishing”, they make the public and policymakers complacent, wasting valuable time. All the while, the share prices and marketing budgets of ESG-focused companies steadily rise, along with carbon emissions. The PR is especially noxious, because you can’t fix a market failure with marketing.
The short-term incentives of business do not always align with the long-term public interest. The deluge of non-binding commitments made by companies usually hail from their communications departments, not operations teams. Although markets have a role to play, they cannot work by themselves. As a result, little ESG work meaningfully affects actual capital-allocation decisions, a prerequisite for corporate promises to have any chance at reducing real-world emissions.
So what ought to be done? We shouldn’t give up on the private sector. Instead, the state needs to be a catalyst to activate it.
A carbon tax is the obvious starting point to change economic incentives, followed by strict industry-by-industry regulations guided by independent experts who set clear and predictable targets that businesses must meet, such as vehicle emissions limits. Governments are more likely to act if the ESG community were honest about the need for them to do so. It has a strong incentive to make the case: the central tenant of ESG investing—that more responsible companies are more profitable—has a better chance of becoming true if the state regulates critical areas and penalises bad behaviour.
For example, if a carbon tax were imposed, then a low-carbon fund should in theory perform better than a regular fund. Across the board, new regulations to protect the natural environment will result in a relative advantage to higher ESG performers and ESG strategies. Although it may dampen short-term equity returns, it will pay off in the long run—and anyway, kicking the can down the road for other generations to clean up is even more costly. It is also morally unconscionable.
A new era of green activism
There is growing unrest, especially among young people, about society’s failure to respond to climate change. The financial-services industry has eagerly rushed into the void, exploiting the social angst by selling a host of “green” products that lack much evidence of effectiveness beyond to fund managers’ bottom lines through higher fees. Selling expensive placebos is great for quarterly earnings, but disastrous for the planet. Little wonder a younger generation is losing faith in capitalism.
If “responsible business” is going to mean anything, it requires taking sides and telling the old guard what younger generations have figured out: inspiring social-media adverts aside, what business is doing isn’t working. At the individual level, if your company is actively lobbying against climate legislation or taxes to fund environmental goals, don’t let your ESG work be a marketing foil for irresponsible leadership. Young employees in particular must lead this charge: tell your chief executives that it’s not acceptable to feign loyalty to saving the planet while misleading the public and pressing politicians to forestall aggressive climate action.
The idea of socially-responsible investing has evolved slowly over decades. It must evolve significantly faster to play a helpful role today. Perhaps covid-19 can be a wake-up call for a new era of ESG activism. Both the coronavirus and the carbon atom are invisible though their effects are not. Both hurt different parts of the world unevenly. In both cases, the views of experts need to cut through the clutter of misinformation that slows down vital decisions. And responding to both is difficult and expensive—but best done sooner than later.
Decarbonising the world economy is hard but possible. Those who believe that companies must act responsibly must also accept that simply wishing for it is no better than endless exhortations to good sportsmanship after a game has deteriorated into widespread dirty play. When that happens, players look to the refs. Businesses and markets have referees too. It’s time that the private sector asks them to do their jobs.
_______________
Tariq Fancy is the former chief investment officer for sustainable investing at BlackRock, the world’s largest asset manager. He is the founder of The Rumie Initiative, a charity to educate children in poor communities.
