Finance Wakes Up: But Are ESG Funds the Answer?

Financial analysts across the globe are slowly waking up to the noisy environmental elephant in the room: climate catastrophe. Investments focused on environmental, social and governance – i.e. ESG funds, have emerged as a knee jerk reaction to the failures of conventional finance. They have also become even more attractive to investors during the worldwide pandemic.

Corporate shareholders, now more than ever, view ESG challenges as a profit-making opportunity. ESG funds, commonly touted as ‘sustainable’ investing, now represent more than one-third of all professionally managed assets in the United States.

In addition, more competing reporting standards have appeared in a wider attempt to resolve the climate crisis. The Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB), Taskforce on Climate-Related Financial Disclosures (TCFD) and EU Taxonomy are all examples of an attempt to standardize sustainable metrics and accelerate the flow of sustainable finance.

On the surface, investors have successfully taken action to prevent a climate disaster.

Not so fast: ESG funds don’t have all the answers

Despite all of this activity among investors, the climate crisis is ever worsening. Countries are far behind their Paris Climate Accords carbon commitments. Extinction among species persists at accelerating rates.

Banks and financial institutions alike continue to finance activities that degrade natural ecosystems. Money continues to pour into top-rated ESG funds and assets, and yet progress is so futile.

A question arises when one finds the British Tobacco Company listed in the Dow Jones Sustainability Index (DJSI) for 19 consecutive years.

Pushing back against constant lip service

Lorraine Smith, a consultant in the sustainability space, has aptly compared ESG to, “less wife beating.” She poses the question, “Why don’t we cringe when companies beat our Earth repeatedly, if a little less than last year?”

She and a team of like-minded thinkers set out to test a hypothesis: Is ESG really broken?

After rounds of interviews with experienced investors, the answer is a resounding yes. One analyst noted that at its most basic, yet most widely used level, ESG is about screening out “vices” from asset classes, but often these “vices” can still make up around 20 percent of a fund.

Other investment managers have revealed that ESG investors simply want to tick a box without actually making an impact. For example, Robert Rubinstein, founder of TBLI Group, summed up these thoughts when he said, “ESG is like a membership card to a fitness club. You can carry the card but you never need to get on the machines, lose weight or get fitter.”

Concerns over incentives were clear. A former CFO of Sustainable Finance at HSBC has said (during an ESG research project in which I recently participated) he has sounded a similar alarm and pointed to short-termism as a reason for failure. Institutions around the globe penalize wealth managers for long-term investments, all the while incentivizing short-term projects. Analysis outside of a 12-month time horizon is a rarity in the field of wealth management.

Yes, there is hope for a more sustainable finance model

So, while the current model of ESG funds looks attractive, it is void of substance when considering its real objective - to heal Mother Nature. It rewards the good, the bad, and the ugly so long as they check the boxes and promise a better tomorrow.

In the midst of all of the despair, there is hope.

A research group of which I am participating, the RegenX team, has found glimpses of a more holistic approach, which some professionals in this field call regenerative finance.

One way of defining regenerative finance is that its approach incorporates systems-thinking to scan for sustainable investment opportunities. Tools the U.K.-based nonprofit Future-Fit Business provide are helping to catalyze this shift by helping business leaders re-imagine their relationship with nature and report on real progress.

Capital Institute, a research group building the foundation for a regenerative economy, has also published an extensive guide on how principles and patterns will shape the new world of finance.

One firm, which is at the forefront of responsible investing, breaks the status quo of short-termism as they reward investors for decisions that bear fruit over years rather than mere quarters. Matthew Patsky, CEO of Trillium Asset Management, says he is proud of his firm’s unique system, which encourages a more pragmatic approach to finance. He acknowledges that while these tactics help, there is much ground to cover in using finance as a means to restore the planet.

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