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To counter the ESG backlash investors must practice real engagement

“Arguably, rather than dampening enthusiasm for greater diversity, shareholder activism and the drive to decarbonise, the ESG backlash should serve to amplify the issues.”
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Growing populism has fuelled a reaction to what some see as unnecessarily ‘woke’ shifts in society. This harsh political and social landscape threatens the progress made on issues of diversity, climate action and alternative energy.

In the US, a Republican-led campaign is getting into full swing to prevent pension funds and other institutional investors from pursuing ESG-based portfolio strategies. Whether this campaign will succeed is open to question, but putting these developments into some kind of perspective, the backlash against ESG is an indication that it is now part of mainstream thought, for businesses and investors.

In many ways, the debate starts now and may be won or lost on how fully investors engage with the  sustainability principles they have signed up to.

Arguably, rather than dampening enthusiasm for greater diversity, shareholder activism and the drive to decarbonise, the ESG backlash should serve to amplify the issues. Responsible investors need not fear this backlash. They should expect to be challenged and this, in turn, will ultimately raise the bar of best practice in ESG investing.

The ESG pushback comes at a time when there is a clamour in more liberal quarters for even greater rigour and scrutiny in the application of responsible investment policy. Investors are being pressed to do more to effect positive change within their portfolio companies. Fund promoters have also been given notice about misleading claims of their green-ness in product disclosure statements. Australian regulator ASIC has hit one of the market’s big fish, Vanguard, with three infringement notices for misleading sustainability-related statements.


Achieving net zero by investing in energy transition

The shifting of attitudes on responsible investing is not confined to the 'woke' backlash. In Sweden, one of the country’s largest pension funds, AP7, has reiterated its commitment to investing and engaging with high-emitting companies in the energy, steel, cement, and transport sectors, helping them transition to more sustainable practices.

This growing realisation - that the global energy transition must include the fossil fuel providers and high-emitting industries - has gained support from academics such as Myles Allen, director of Oxford Net Zero. He is adamant that no amount of investment in alternative energy will achieve net zero; indeed, that investors should increase their exposure to fossil fuel assets.

John Pearce, CIO UniSuper in Australia, said his investment team is focused on companies that support decarbonisation, which for them means investing in industries that will facilitate the transition. “It’s impossible to decarbonise without essential metals like copper and steel, and we see companies that produce these products as part of the solution."


Transparency in China and Russia

Investors’ ESG strategies are on the shakiest ground when it comes to the more societal aspects of ESG. This not just about woke-ism and the backlash against perceived political correctness. It is at least partly due to concerns about the potential risk of investing in autocratic regimes, where transparency is limited. The elephant in the room is the fact China’s ESG scores are amongst the lowest in the world.

Two recent events have unnerved foreign and domestic investors: the 2022 freefall in China’s US$55 trillion real estate market and the highly publicised political crackdown across the tech sector. This is something China investors must address if they are placing themselves on a higher ethical plane.


Asset owners’ ESG reliance on asset managers

There is a danger that the anti-ESG pressure on institutions will encourage investors to hide behind their external asset managers and voting proxies. Many Asian asset owners rely on their external managers to exercise voting rights in line with the fund's proxy voting principles. Discretion is often given to the fund managers to determine which ESG issues they deem to be critical, specify goals that they would like to achieve as a long-term investor, and proactively engage with investee companies on these issues. In many cases, the asset owners do not give directions on which ESG issues they should engage with investee companies.

An over-reliance on ESG data analytics firms such as MSCI and Sustainalytics is also seen as part of the problem. Sustainability expert Sasja Beslik cited MSCI’s decision to downgrade its ESG rating of the Russian government from B to CCC as "eight years too late.”

Blended Capital Group CEO, Paul Clements-Hunt suggested that ESG should be called into question for failing to halt the flow of investment to the Russian regime.

If asset owners do not add their own voice and action to the many ESG challenges, there is a higher risk that targets and objectives are not achieved. Maybe it is too much to ask of traditional conservative institutions, to truly have the courage of their convictions.

Posted 20 March 2023

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