The unintended consequences of ESG investing — and how to prevent them

An extraordinary trial kicked off here in London yesterday, when six former executives of giant commodity trader Glencore appeared in court to face corruption charges related to bribes allegedly paid to officials in Africa.

The allegations reflect long-running concerns about the damaging effects that unethical behaviour by multinational businesses can have in developing nations. But even well-intentioned moves by global investors can have nasty side-effects, as I highlight below. Also today, Lee notes an interesting investor perspective on the US government’s clean energy strategy. Thanks for reading.

— Simon Mundy

EMERGING MARKETS

A lesson in harm reduction

Of all the criticisms made of environmental, social and governance-focused investing strategies, one of the most serious is that they can risk curtailing investment flows to developing nations.

As we’ve written before, researchers have raised concerns that ESG investors’ concerns about workers rights and other social issues may lead them to avoid poorer countries with weaker protections.

And efforts to lower financed emissions may steer investors away from developing countries, such as India and Indonesia, that have relatively carbon-intensive electric grids. More broadly, those who require fulsome sustainability data around their investments will find such data much easier to come by in richer nations.

So what should institutional investors do about this? Some useful food for thought came yesterday from the non-profit World Benchmarking Alliance, as it launched a new initiative focused on addressing these challenges.

The project has heavyweight backing from the Office of the New York City Comptroller, which oversees pension funds worth more than $240bn, as well as UK insurer Prudential, with assets of $174bn.

WBA, which aims to drive progress by setting clear benchmarks around sustainability, has suggested several steps investors can take to ensure that their ESG strategies aren’t having a punitive effect on developing countries.

For one thing, they can use country- or region-specific transition pathways so that their investment criteria allow for less rapid decarbonisation in developing countries than in rich ones. They can aim to ensure that their engagement with companies reflects the varying national environments in which they’re operating.

Another suggestion is to assess how the ESG data and ratings that they use may be skewed to favour developed-world countries, and apply “overlays or adjustments” to offset this. And when an investor’s ESG framework still clearly requires them to exit a developing-world asset, they can invest in another to maintain their overall exposure, WBA suggests.

As a first step, it makes sense for investors to do a serious analysis of their existing strategy, and to what extent it may cause the unwelcome side-effects outlined above. As WBA financial system lead Andrea Webster put it to me yesterday, “the race to net zero will be won or lost in emerging markets”. (Simon Mundy)

Energy transition

Ninety One: US opted for ‘a slower, more expensive transition’

The head of sustainable equities at London-headquartered asset manager Ninety One thinks the US is paying a high price to win political buy-in for its green energy overhaul.

By subsidising domestic manufacturing and deterring Chinese-made green goods, Deirdre Cooper told me, “the US has effectively made a decision to have a slower, more expensive transition”.

But while Washington’s focus on standing up US clean tech is attracting attention, Cooper argued that middle-income countries’ demand for green technologies would outperform forecasts. Currently, she said, demand was “not at all reflected in share prices”.

“The market tends to over-anchor a little bit on the US and say, ‘Well, if you can’t export to the US, it’s no use’,” she said. But emerging markets have the potential to counter the US’s clean tech prowess as the latter becomes a “closed market”.

The global environment portfolio Cooper manages includes Dublin-based auto tech company Aptiv; US and European energy giants NextEra Energy, Ørsted and Iberdrola; Power Grid of India, one of the world’s largest transmission utilities, and Chinese manufacturers such as lithium battery maker CATL and solar panel glass producer Xinyi Solar.

Cooper, who also sits on the finance advisory board of the International Energy Agency, pointed to a surprising trend in electric vehicle adoption as one example of how decarbonisation could be a growth driver in emerging markets even sooner than expected.

IEA had previously forecast that rich countries would be quicker to adopt EVs, since their populations could more easily afford them. But China’s inexpensive EVs have boosted uptake in developing countries such as Thailand, where the number of EVs quadrupled last year, according to government figures. Meanwhile, tough US trade barriers have effectively shut these models out of the American market.

The White House, for its part, has made the case that domestic production of clean tech is both a national security imperative and a job creator.

Cooper is unconvinced. An energy system that relies on imported fossil fuels — such as Europe’s reliance on Russian gas — faces clear vulnerabilities, she said. Petrostates have leverage over fuel importers, since they can effectively turn off the tap.

While shifting the economy to batteries, solar panels and other clean tech will require a one-off push on installation, the switch will ultimately make nations more self-sufficient.

As a result, Cooper said, she doesn’t buy the argument that a large domestic solar panel manufacturing industry is necessary for energy independence.

“From a national security perspective I don’t really see the reasoning,” she said. “I think it is performative.” (Lee Harris)

Smart read

A major new report by former Italian prime minister Mario Draghi grapples with how the EU can strengthen its economic competitiveness while maintaining its green growth commitments. The FT editorial board gives its verdict.