Is ESG doomed? Not if asset owners engage

Missed opportunities at COP26 has re-emphasised the need for tough company engagement

Tom Eckett

Glass globe green ESG climate

In November, ETF Stream’s founder and strategic adviser David Stevenson wrote a thought-provoking article, titled ESG is doomed, which criticised a variety of different facets of the ESG industry, including engagement.

“There is though a wrinkle in this argument around engagement,” he wrote. “One can see an argument for an ESG-style investor haranguing an oil company to improve their methane emissions policies – but in truth, most fund managers have neither the time nor the disposition to be a pain in the ass with corporates.”

His views are supported by a recent paper from EDHEC-Risk Institute which analysed data of 6392 companies from 68 countries between 2007 and 2018 on the impact of shareholders on their investees’ carbon-sales intensity. The results showed institutional shareholders “do not reduce” their investees’ carbon footprint.

How asset managers engage is at the forefront of investors’ minds following the COP26 summit which showed government agreements alone will not be enough to reach the 1.5°C targets needed to negate the risk of climate change.

According to research conducted by the United Nations, even if all countries meet their commitments made at COP26, the temperature rise could be kept to around 1.8°C by the mid-century, short of the 1.5°C targets. This highlights the responsibility of companies – and therefore shareholders – in aiding in the transition to a low carbon economy.

Therefore, is ESG doomed? Or is there an opportunity for investors to have a genuine impact by putting pressure on asset managers to engage with companies and move beyond what has been seen in the past as a box-ticking exercise?

For me, there is no doubt engagement is a far more effective tool than divestment. Divesting should be seen as a method of last resort if an asset owner’s engagement has fallen upon management’s deaf ears.

The biggest risk of divestment is the company ends up in the hands of an investor such as a hedge fund that has no interest in keeping management honest in their sustainable practices.

As Stuart Kirk, global head of responsible investments at HSBC Asset Management, told ETF Stream, markets run the risk of allowing private capital to hoover-up low-scoring ESG stocks if investors continue to divest amid growing pressure from shareholders.

His views were echoed by Christopher Mellor, head of EMEA ETF equity and commodity product management at Invesco, who told ETF Stream: “If you divest from the more carbon-intensive areas, there will still be another investor owning those stocks as every time you sell on the secondary market, someone else is buying. If that buyer is less engaged on climate, then pressure is off for management. Engagement is a better option than divestment as ultimately you keep your voice.”

However, this does put pressure on asset owners to make engagement the effective tool it has the potential to be. BlackRock has led the way among passive managers by offering index investors the opportunity to directly engage with the underlying companies.

The world’s largest asset manager has come under fire several times in the past few years for failing to play its part in the shift to a more sustainable future. Highlighting this, BlackRock voted at just 12% of climate resolutions, according to a 2020 ShareAction report. However, its latest move will give investors greater powers when it comes to holding companies to account.

The EDHEC-Risk Institute paper shows asset owners’ impact has been negligible so far. However, the paper also found investors do “contribute to the carbon emission reduction for the most polluting companies” highlighting the crucial role asset owners have in “complementing” international climate policies.

This article first appeared in ETF Insider, ETF Stream's new monthly ETF magazine for professional investors in Europe. To access the full issue, click here.

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