Long reads

Busting sustainable finance myths: Why Tariq Fancy is only half right on ESG, part 2

Hamish Monk

Hamish Monk

Reporter, Finextra

Blackrock’s former sustainable investing chief, Tariq Fancy, has made nine key claims against the environmental, social and governance (ESG) movement. While the ensuing discussion has shone a light into some of the asset management industry’s darkest corners, there are some myopic myths that need to be busted.

Finextra, alongside founder of Responsible Risk, Richard Peers, has revived its mythbuster column to address each of Fancy’s claims. This article, part two in the series, will analyse claims 5-9. To read part one, click here.  

Claim 5: 

Telling people that where they park their retirement savings is going to help save the world (it won’t) distracts them from doing things that will save the world.

First, let’s look at the figures. According to the campaign director of Make My Money Matter, David Hayman, having a green pension is 21x more effective at cutting our carbon footprints than stopping flying, going vegetarian and switching energy provider, combined. Much of the UK’s £2.6 trillion of pensions is being invested in fossil fuels, tobacco, the destruction of the Amazon rainforest, and other dirty business.

“We have found that our pensions are responsible for enabling 330 million tonnes of carbon emissions every year,” said Hayman in a COP26 session. “To put that into context, that's more than the UK’s total CO2 output.” If our pensions industry was a country, it would be in the top 20 global emitters.

Clearly, moving our pensions to greener providers will be impactful. Pension funds, as institutional investors, automatically have a long-term perspective on how they invest. It therefore makes a lot of sense for institutional investors to take ESG seriously, as a fiduciary duty. Thankfully, financial technology is moving in to help both providers and customers make their pensions more sustainable. Scottish Widows, for instance, recently launched a two-way fintech communication dashboard that enables customers to view and manage how their pension is being invested.

Robert Armstrong points out that asset managers may be using the secondary market, which throws into question how impactful pension investment can be as a climate change-fighting tactic. “There should be no perceived harm in concentrating secondary market dealings on green companies,” contested Maya Hennerkes, associate director, ESG sector lead for financial intermediaries, European Bank for Reconstruction and Development (EBRD). “Although it is less powerful than primary market activity, it does send out a strong signal.”

Indeed, the secondary market is valuable for shunning investments that we do not agree with – otherwise, why don’t we just get rid of the marketplace altogether?

This is not to say, of course, that pensions are a panacea. Adam Robbins, Triodos Investment Management, thinks “we should look at our pensions as saving for a world we would like to, or can, live in. As an extreme example for the sake of argument: what would be the use of a massive pension pot if the islands you planned to retire on are submerged, as a direct result of your investment?”

It is important to remember that the vast majority of people in the UK may not invest outside their pension, so this could be their only opportunity to make a difference economically.

Hennerkes agrees: “We need all hands on deck. We as individuals should not be let off the hook – we need to make informed decisions about the future. If I can choose whether I put my savings or pensions in a green pot or not, then it is important I take the responsibility and make a sensible choice.”

Rebuttal: Our wallets can help save the world; fintechs, consumers, and pension providers all have a role to play. It is to submit to doomism to think that moving retirement savings (as invested in brown industries as they are) will not have an impact in fighting climate change. Also, for the record, what does Fancy think the planet-saving thing is that we are being distracted from, by focusing on the sustainability of our savings? We would all like to know.   

Claim 6: 

Green bonds are just a capital arbitrage opportunity.

To have a fair shot at tackling the climate crisis, we need to place faith in the environmental utility of all asset classes.

“I'm a big fan of green bonds in the primary market, I think they can be very impactful,” said Hennerkes. “When a company or bank chooses to raise debt – under the Green Bond Principles (GBPs), for example – and channels proceeds into green projects, that institution will have to do a lot of work to materialise those projects, and back up the issuance.” In short, there are other, easier channels to secure capital arbitrage. 

The EBRD, for its part, supports the issuance of green bonds, and is an issuer itself. In September 2019, for example, the bank issued a climate resilience bond worth $700 million. The proceeds are now being used to fuel climate resilience projects. “This was the first global climate resilience bond, and it is challenging to find good quality projects to back up such an issuance,” noted Hennerkes. This kind of activity is more than a capital arbitrage grab – it has a domino effect of pushing market dynamics in the right direction.

To ensure the proliferation of green bonds in the marketplace goes beyond a means for companies to raise more capital (and potentially at a slightly lower coupon at the moment, due to demand) we must go beyond data, or the GBPs, argued Robbins. Currently, there isn't total certainty that a bond’s proceeds will be going to fully sustainable or impactful solutions.

Again, it is a case of digging deeper. Triodos, for example, looks beyond the GBPs and judges whether the company itself meets the bank’s criteria – as opposed to just the debt instrument itself. Similarly, EBRD will review the bank’s environmental and social policies holistically.  

A data piece

Robbins is right to point to the importance of rich data in this area – which, incidentally, Fancy claims there isn’t enough of. On the contrary, a recent ODDO BHF AM report, ‘Weathering the storm of ESG complexity by leveraging AI’, states there is a wealth of data, just divergent ESG rating methodologies. “Hence, using one provider as a benchmark is not the best approach to deliver strong results,” said Martina Macpherson, head of ESG Strategy, ODDO BHF AM.

Thankfully, new AI and machine learning (ML)-based analysis technologies, which filter quantitative and qualitative ESG information from multiple sources, can provide a meaningful approach to complex data management, oversight, and alignment of frameworks – acting as a catalyst for sustainable investing at scale, says the ODDO BHF AM report. With these technologies, data and framework complexity management in ESG can be converted into an opportunity for financial institutions. By triaging multiple ESG data inputs, a holistic and long-term view on ESG risks and opportunities can be established.

Rebuttal: While green bonds can be a means to secure capital arbitrage, they primarily serve to channel capital toward critical decarbonisation projects. Frameworks and fintech – enabling deep data analysis – will improve decision making even further. As our green bond frameworks and technologies develop and mature, this feedback loop will become even more powerful.  

Claim 7: 

To change the financial calculus of the corporate world, ESG investing would have to be measured in the many trillions, and it isn’t getting there because the effect of ESG investing is weak, there will never be enough of it.

While this may be partially true, there is hope for the future; ESG investing has grown exponentially in the last decade and is estimated to be somewhere between 35.31 to 40.52 trillion USD today, notes Macpherson. According to a Bloomberg article, global ESG assets are on track to exceed $53 trillion by 2025 – representing over a third of the $140.5 trillion in projected total assets under management. “A perfect storm created by the pandemic and the green recovery in the US, European Union and China will likely reveal how ESG can help assess a new set of financial risks and harness capital markets,” reads the piece.

As touched upon earlier, there is also great potential in the next generation of tools and data – harnessing fintech and AI – to upscale the impact of ESG investing. Once we can properly rationalise ESG data, we can measure our influence more accurately, and use it to inform truly meaningful action. Over the last decade, points out the ODDO BHF AM report, the asset management industry has been gearing up for a massive adoption of ESG data within investment decision-making, and expanding in-house ESG models, methodologies, and teams at scale.

Indeed, “new fintech and AI-backed business and investment models will go a long way toward addressing key investor concerns, while supporting a regulatory push for more consistency and transparency in corporate reporting, auditing and ratings analysis.”

There are other additional drivers of ESG investment worth a mention here. Better frameworks – such as the International Capital Market Association (ICMA)’s principles for green bonds, sustainability-linked loans and bonds, and the Equator Principles – all provide the market with greater clarity on how to structure ESG-related financial products. The rise of ESG-related reporting regulations, meanwhile, such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) and Corporate Sustainability Reporting, will all have a domino effect on banks and investors to upscale their internal ESG practices.

As ESG investing escalates, so too will its potency.

Rebuttal: The ESG investment industry is still in transition – with rapid developments across strategies, approaches, and technologies. All these factors are serving to scale up the industry and reshape it toward best standards of practice.

Claim 8: 

Corporations have been designed over centuries as profit-seeking organisations with a responsibility to increase shareholder wealth. Trying to turn them into stakeholder organisations on the fly will fail.

No one expects this fundamental shift in our attitude toward economics to happen overnight. Fortunately, the industry is starting to recognise the merits of a stakeholder approach. “Stakeholders are now becoming as important as the governments that finance us, or that put our capital together for us – because they're part of our universe,” said Hennerkes. “We need to explain things to them and sometimes even change the design of projects.”

The EBRD, for example, already conducts a broad stakeholder engagement process around every direct investment, over a certain risk threshold or size. Hennerkes says this gives the bank its social license to operate.  

Failing to factor in the stakeholder element can have real-world consequences. There are countless projects where misalignment with local communities and expectations has caused operational disruptions, or delays in construction and project development – all of this costs money. Areas such as greenfield development, or mining, have been grappling with these issues for some time now since they are highly visible projects.

There is already a very clear financial and ethical incentive to transition to a fully-fledged stakeholder capitalism model. Once again, with a price on carbon and natural capital this economic philosophy would be much more easily internalised.

Rebuttal: In the short term, avoiding the stakeholder approach can save a bit of money; consultations can be scrapped, analysis of alternatives can be circumvented, and design changes to projects or the financing structure can be ignored. For long-term stability, however, inputs from stakeholders will have to be considered.

Claim 9: 

We do not want Wall Street people deciding what is good for society.

Yes, the market system is partially responsible for the position we are in today. So how far can we genuinely trust it to get us out of this situation without a proper change in behaviour?

According to Fancy’s boarder philosophy, free markets do not exist in practice since they are always subject to rules and regulations of some kind. Fancy, in step, turns away from ‘Wall Street’, and to governments to provide the legislation needed to steer the industry toward decarbonisation.

“To some extent, he's right on this,” conceded Murray. “However, this goes back to the ‘ecosystem’ point; no one can save the world in a vacuum.” It is vital that efforts come from both the asset management industry and regulators.

Ultimately, this comes down to raising the price of carbon, in the form of carbon tax – to a tune of $75 per tonne by 2030, suggested Mark Carney, UN special envoy for climate action and finance, at a COP26 session. Murray is supportive of this idea: “I have talked to many climate scientists, and they talk about a carbon price of $150-200 dollars per tonne,” he said.  

These suggestions may concern neo-classical economists, but it is time to seriously start questioning whether economic growth itself is the worthiest of aims – or even achievable permanently; particularly in a world so constrained by resources. If the planet was a balance sheet, we are in a loss: exploiting 1.6 times more Earths than we have.

Rebuttal: There is $44 trillion associated with nature at risk. The scale of the challenge ahead of us is so vast that we need support from both the asset management industry and governments to execute a successful green transition.

Team ESG thinks back

The question on everyone’s lips is, what is Fancy’s motivation? Is it a genuine call to action for the asset management industry to repair the chinks in its ESG armour? Or are the more divisive claims just a fig leaf to cover the fact that this is an attempt kindle interest in his person? We would all like to think the former is the case. Either way, there is a lot more hope for ESG investing than Fancy lets on.

What matters most here is integrating more ESG factors into the investment process so the cost of capital for green companies is brought down, the speed of adjustment increases, and the incentive for entities to scale up their ESG practice intensifies. 

The original sin in the story of the planet’s destruction is the lack of a price on carbon and natural capital – this is our missing link.

To join this important discussion around how the asset management sector can help spearhead the transition to net zero, register for Finextra's forthcoming Sustainable Finance Live event, from 1-2 December, here.

Comments: (0)