Herve Guez, Head of Responsible Investment Research at Mirova, comments on the ESG backlash in the US.

ESG will prevail?

It is a paradox. Despite the increasingly visible effects of climate change, changes in economic and industrial regimes, and people’s desire for greater transparency, sustainable finance has never felt so under attack. In a changing world, the environmental, societal and good governance (ESG) concerns that guide thousands of investors no longer serves both the interests of companies and savers. Three years of crises, the Covid-19 pandemic, the war in Ukraine, geopolitical tensions, rising inflation, etc. have been enough to take this type of investment from glory to despair.

Woke Capital
One of the most aggressive attacks in recent weeks came from the United States, where many of the world’s largest pension funds and asset managers boast of investing according to ESG criteria. In a book entitled “The courage to be free”, the Republican governor of Florida, Ron DeSantis, a possible candidate in the next American presidential primaries, calls on politicians to remove the influence of “woke capital”, in other words ESG. His reasoning: by imposing investment rules, this “woke capital” goes against individual freedoms. It is a way of reaffirming that the fiduciary duty of companies takes precedence over their environmental, social or governance obligations. ESG could therefore be useless or even harmful to shareholders.

This criticism has been heard repeatedly. For some, ESG can only be one of the criteria to be taken into account before an investment is made, in the same way as the analysis of the balance sheet, the income statement or the cash flow. It would therefore only be a single element of good management. However, at the moment with everything our world is going through, ESG must take its place and be much more than a simple decision-making tool. Investing in a company must make a real impact. Finance can serve as a way to contribute to a more sustainable and healthy economy, for the benefit of people, companies and therefore their shareholders.

Consider the case of the United States. Their pension funds collect a large part of the savings of American households. As a result, they have long-term liabilities that must be covered by investments with the same time horizons. By allocating to ESG, the funds send a price signal to companies, which will have a positive effect on the sustainability of the economy and is therefore beneficial to the pension funds. By directing capital towards companies with better ESG practices, the companies benefit with a lower cost of financing, which in turn creates a ripple effect in the market, sending a message to less virtuous companies who do not enjoy the same advantages.

This commitment can be even more impactful if the capital goes to smaller companies whose projects and jobs are often local, whether or not they are listed on a stock exchange, and which have greater new financing needs than larger, mature companies.

Such can be the impact of ESG. But why should this appear contrary to the concept of individual freedom and fiduciary duty brandished by Ron DeSantis? If an individual investor wants impact, what right does anyone have to prevent them from doing so? And how does it harm value creation? On the contrary, a capital allocation guided solely by short-sighted financial performance considerations contributes to a failing economy, which is detrimental to long-term performance.

Doux Commerce
Before the recent crises, our economies were built on shareholder value maximization and open rules around competition, with the belief that this would be a way to develop democracies according to the concept of “doux commerce” – where the thought goes that commerce acts as a civilizing force. There have been undeniable benefits around the world. But the events of the last three years have shown the limits of ’doux commerce’ Authoritarian regimes like China and Russia have tamed capitalism without losing their power. The development of their economies has been to the detriment of industries in other countries due to the relocation of manufacturing, with significant consequences for employment and thus for their middle classes. ESG is also a way to defend the values and sovereignty of our democratic economies.

Short-term gains for shareholders and protecting prices paid by consumers cannot be the only guides. On the contrary, these crises show that it is even more important that when you invest in a company you need to care what it does with that money and what consequences there might be for the environment and for employment. So, it’s not just a case of investing in companies that relocate, but it is worth thinking about how you want to invest. In the past, maximizing the risk/return ratio was the key objective of investors. This proved to be a myth. Markets are not efficient and real life, including finance, is much more complicated than that. Politicians and regulators have understood the new global economic challenges. Tighter investment rules are inevitable. Our transformed world will serve as a moment of truth for ESG.
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