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March 22, 2022

Ukraine unearths the intellectual limits of ESG today

When the need to act assertively is required, responsible investors have been found wanting. And those who don’t believe ethical investment is their bag are being dragged into the debate whether they like it or not.

By Vibeka Mair

Bad maths: are financial institutions cut out to make strategic responsible investment decisions? (Photo by gpointstudio via iStock)
  • Serious doubts arise as to whether the financial industry has the intellectual clout to contend with ESG risk management.   
  • Institutions who don’t see ethical investment as part of their remit are paying the financial costs of sanctions regardless, begging the question whether they have to factor ESG in.
  • The debate comes as research finds hundreds of ESG funds are exposed to Myanmar’s military junta, prompting fresh allegations of greenwashing.

It’s no secret that the $330bn ESG funds industry is facing a credibility crisis – the Russian invasion of Ukraine is prompting questions as to why fund managers and asset owners were exposed to Russia in the first place, given the country’s poor (and very obvious) record on governance and human rights.

Tariq Fancy, a high-profile vocal critic of ESG, told Financial News last week the Ukraine war effectively “bankrupts the ESG case”. The former sustainable investing CIO of BlackRock argued the event highlights all the philosophical inconsistencies buried within simplistic ESG branding.  

Speaking to Capital Monitor, James Alexander, CEO of membership body the UK Sustainable Investment and Finance Association, says: “What this really sad situation shows is [what] we need to consider when it comes to responsible and sustainable investing is huge.”

Alexander says investors have to get to grips with company-level risks, systematic risks such as climate change and geopolitics, and also top-level governance and country-level factors.

“It’s imperative that sustainable investors look at the countries their investments are operating in, the potential for human rights abuses – such as waging war on other nations – and think about the extent to which the companies you are investing in are part of that regime.”

Not all financial institutions have been oblivious to the risks of dealing with Russia. For years, asset owners had been lobbying oil majors BP and Shell to exit, “obviously without success if you look at what’s happened”, Alexander says. “They’ve lost billions and billions of dollars for not heeding that investor advice.”

While acknowledging that investors need to balance managing risk and not severely restrict their investment universe, Alexander says Russia’s invasion of Crimea in 2014 should have told responsible investors all they needed to know about Putin’s politics. It is unclear which investors pulled away or back at that stage, but certainly not enough.

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Nathan Fabian, chief responsible investment officer at the UN Principles for Responsible Investment, agrees, and adds that third parties were flagging the risks. “Some ESG data providers have been issuing warnings on Russia since [2014] and again in the weeks before this invasion, especially those focused on controversy monitoring and market sentiment.”

For some, it required the mobilisation of thousands of Russian troops on Ukraine’s borders for the alarm bells to ring.

For example, PensionDanmark, with $41.1bn of assets under management (AUM), sold all its Russian government bonds and any exposure to companies where the Russian government has a deciding influence just “weeks” before the invasion began in late February. “With the aggressive actions taken by Russia we have no desire to support the Russian regime,” Torben Möger Pedersen, CEO, told Capital Monitor on 25 February.

Responsible investment: not our problem

Not everyone agrees, however, that it is the place of the financial community to take such decisions. David Solomon, CEO of investment bank Goldman Sachs, told Time on 13 March that it was not the job of Wall Street to ostracise Russia. The US bank is presently exiting Russia in compliance with US sanctions.

It is not clear if Goldman Sachs’ $2trn asset management arm is entirely aligned with the bank. It issued a statement on 6 March saying it would suspend all purchases of Russian securities and reduce exposure “in the best interests of its clients”, but also added it was “heartened by the degree of global coordination by governments, businesses and regulators in pursuit of peace”.

But for some investors the boundary is clear: divesting from Russia is firmly within their remit. Kiran Aziz, head of responsible investments at Norwegian pension fund KLP ($80bn AUM), says: “Apart from the ability to divest, this decision also reflects our commitment as a responsible investor and the signal we want to send out by divesting.”

Analysis of the 15 ESG fund managers with the most exposure to Russian equities by AUM reveals that irrespective of your position on responsible investing, being caught exposed to assets owned by institutions that do take it seriously will cost you financially.

Based on data from research firm Morningstar, the chart below reveals the extent by which exposure to Russian stocks, either through divesting (presumably at fire sale prices) or through holding on to them, has dropped. For context, the Moscow Exchange (Moex), Russia’s benchmark stock index, was down almost 30% on 24 February, wiping out roughly $259bn in value.

And it’s not just the Ukraine war that is highlighting the need for consistency. On 9 March, an investigation conducted by non-governmental organisations Inclusive Development International, based in North Carolina, and Alternative ASEAN Network on Burma, alleges that 344 ESG-labelled funds are exposed to companies with ties to Myanmar’s military junta.

Mark Farmaner, director of Burma Campaign UK, says: “ESG is meaningless if companies included in ESG funds are in a business relationship or otherwise helping to fund a military which is responsible for genocide, war crimes and crimes against humanity.”

Passive resistance

The tragic events in Ukraine have started conversations on many aspects of finance, not just ESG investing, but also the conventions of passive funds after the active removal of Russian stocks from indices.

A fund manager for one of the 15 asset managers noted above and speaking on condition of anonymity, argues it is hard to know “where to draw the line” on deciding what stocks to include in ESG funds, and questioned the inclusion of Chinese stocks in many.

This is certainly a difficult challenge, but it is a line that institutions that claim to care about such matters must draw. Otherwise, what is the point?

“[ESG] has become a fitness club where everyone shows their membership card but no one goes to exercise," remarked Robert Rubenstein, serial social entrepreneur and founder of Dutch-based Triple Bottom Line Investing, on LinkedIn in March. “[The] only ones benefitting are service providers and fund managers. Not society and the environment. We need a better system, fast. What would you do?”

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