One side effect of the collapse of cryptocurrency giant FTX has been to shine the spotlight on the movement that has been gaining significant traction over the last few years – that of ESG in our business affairs or the workplace. ESG stands for Environment, Social and Governance. At its best, it’s a sincere desire to measure and promote certain socio-economic goals and principles that have been difficult to gauge and advance, such as a commitment to a diverse work force, sustainability, combatting climate change, and supporting other beneficial goals. Imposing limits on the kinds of investments that institutional investors, like public employee pensions, may invest in is one example of ESG at work, However, at its worst, ESG can become an attempt by people of certain political persuasions, or possessing certain agendas, to force their own ideologies on others in society by limiting access to the capital of those companies that do not adhere to the standards that these people attempt to impose upon them.
The man most associated with ESG has been Blackrock founder and CEO Larry Fink. In 2020, Fink first became associated with ESG when he wrote, in his annual letter to investors, that executives must “reallocate their capital into sustainable strategies.” That letter caused a substantial reaction from conservative leaders and elected officials, who then signed a letter to Fink asking him to “reconsider.” Instead, Fink went the other way. The next year, he added to his annual letter a note about “shareholder capitalism,” which is often code speak for suggesting that corporate boards should be concerned with more than the overall financial health of the company, such as merely making a profit or maximizing share value. Instead, boards should be equally concerned with doing social good, presumably, to be measured by the individual values of those demanding ESG to be considered, as opposed to the values of the board members or the shareholders themselves.
Unfortunately, nobody yet has come up with an acceptable definition of what metrics should be involved in developing an ESG score, or how to measure or weigh them. There is also the business judgment rule to be considered, which is a longstanding principle of corporate law that assumes if not directs a corporate director or officer to act in the best interests of the corporation, which normally means the maximization of profits and share value. After all, isn’t the basic mission of “for profit” corporations to – well – make a profit? The result of this uncertainty is currently an amorphous collection of ideas and viewpoints about ESG that often are self-contradictory, and that sometimes can lead to unexpected, and undesired, results.
Nowhere was this more obvious than with FTX, which now is the very poster child of corporate mismanagement. However, to illustrate the anomaly, shortly before the bottom fell out, one of the entities claiming to give ESG scores, Truvale, actually gave FTX a higher rating for corporate governance than Exxon-Mobil. This was despite the fact that FTX did not even have a true corporate board at the time and that, upon its recent bankruptcy filing, FTX was lacking in the most rudimentary financial controls.
FTX certainly was an extraordinary case, and hopefully an isolated one, but the issue highlighted by its disproportionate ESG score is important, especially when financial institutions are pulling back from potential borrowers who don’t have an ESG program or else have a low ESG score. Nowhere is this more of an issue than with the fossil fuel industry.
Undoubtedly, this industry is not favored under current mores and other standards dictated by the environmental and social justice movements. However, is the ESG movement actually creating a business situation that causes the exact opposite results to occur than what it intends? How, for example, can we really make a full transition to electric vehicles by 2030 or 2035? Where will we get the rare earth metals needed to do that? What would that mean to the child-laborers in the Congo who continue to have to mine the cobalt under appalling conditions? What happens if the war in Ukraine expands, or if the Chinese Communist Party attacks Taiwan? Already, countries like China and Germany are doubling down on coal. Clearly, that is not good for the world environment, and it does not fit in well with the standards and goals of the ESG movement.
The backlash against ESG is unquestionably gaining momentum. Already, Mr. Fink has complained that attacks against ESG are getting personal. And recently, Florida Governor Ron DeSantis announced that the state would be pulling $2 billion in state pension funds from BlackRock’s management as part of a Republican backlash against ESG and sustainable investing.
If ESG is to flourish, or even to survive, it will need to develop a unified and objective set of criteria that take into account the long term implications of what it is measuring, and not just espouse an amorphous set of feel good principles that seem to be following a strict social agenda associated mostly with the left, but do not pay adequate attention to validly competing political orientations or interests. Most agree that energy transition to non-carbon sources is an intrinsically positive goal, but how we handle it – and get through the many impediments and diversions that get in the way of progress – is vitally important as well.
For ESG to take its place as a force for positive change, those behind the movement will have to show they can think deeply about, and handle, the many tradeoffs that will need to be addressed in the future, and not just rigidly adopt a particular partisan ideology without recognition of the short and long term consequences.
- David Shechtman & Matt Meltzer Prepare FAQ Memo for National Structured Settlement Trade Association
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