ESG’s Greatest Obstacle: The Reluctance to ‘Sacrifice’

COP21 and COP22 should be hailed, if for different reasons than they currently are. For whilst optimism appears sky-high and much needed attention is being given to the topic (reflected in the number of ESG conferences taking place in recent times), the reality is that the investment world (or worlds) is now embroiled in a game of ‘who blinks first?’

The reasoning is quite simple; with a global economic recession, the necessary changes to key carbon-intensive industries such as fossil fuels have become less appealing as policy makers lack the appetite to increase unemployment in the short term for long term economic gain.

More importantly, COP21 and COP22 have failed to solve the key controversy that has hindered movement towards a more ESG friendly investment environment; that the ‘West’ became the ‘developed world’ at the expense of the environment via carbon-heavy development policies over decades, and are now requesting the ’developing world’ or the ‘East’ not to do the same.

In other words, the rhetoric in China, India, Malaysia and even places such as Singapore is:

‘Why are we asked to compromise our development when you (the West) caused the problem in the first place?’

In all honesty, it is hard to argue with the logic and it is from this basis that the emphasis has been on a ‘win-win’ solution, carefully avoiding any rhetoric that suggests the concept of sacrifice, whether that is in encouraging asset-owners to divest from carbon-heavy projects and invest in more ESG-friendly projects, or encouraging policy-makers to impose stricter regulation in the pursuit of the 2 degree target.

However, this realpolitik has created a bubble in the discourse surrounding ESG that must burst if genuine and substantive impact is to be made. In other words, the investment world and policy makers must accept that a ‘win-win’ solution is nigh-on impossible and the debate must move to the concept of sacrifice.

Such words are generally heresy in the investment world. At the end of the day, it is performance first and foremost that matters to both asset-owners and beneficiaries. It is near-blasphemous for an asset-owner to sit in front of a client and sell the picture of a better world for which they must pay the price in the form of lesser returns. The theory is that this will generally result in clients going elsewhere.

However, ‘sacrifice’ here does not necessarily mean lesser returns and this is the unfortunate myth that seems to have been propagated and which deters hardcore investors from seriously embedding ESG practices in their investment policies. For example, investing in astro-turf football pitches that have demonstrated an incredible social impact in driving children and teenagers away from idleness, alleyways, and other mischief to a meaningful pastime is generally considered, return-wise, a lucrative investment and few would abstain from seriously considering its inclusion in any portfolio. This is an example of a lucrative ‘ESG’ project, dispelling the prevailing subconscious prejudice that ESG equals less returns.

Therefore ‘sacrifice’ does not necessarily mean lesser returns. Instead, ‘sacrifice’ means accepting greater risk in returns. ESG investments are generally considered to carry greater costs, whether that is in assessing the environmental impact, the carbon-intensity involved, the social impact, tribal land rights (if applicable), commissioning reports from expert consultants and activists, the list could go on.

The political risk is greater, particularly given that as Europe subsidises renewable energy in light of  already meeting energy demand, the more lucrative opportunities are generally in the ‘developing’, and perhaps more ‘opaque’, world. Before the current oil price crisis, oil economies were not particularly interested in the likes of renewable energy and any current and rather sudden interest is more a result of intense a knee-jerk economic diversification reaction than any emphasis on a sound, long-term economic plan. This leaves the risk of increased bureaucracy in the event oil prices go up again, which would reflect sudden deflated interest. Even in non-oil based economies, the political will remains lower than that demonstrated towards carbon-intense industries (though that is changing ever so slowly following COP21-22).

If one could navigate the politics in more opaque areas such as North Africa and Sub-Saharan Africa in the construction of renewable energy that capitalises on the intense sunlight in the Sahara desert, then there is no doubt that such a project could surely provide returns of similar levels to more ‘ESG-unfriendly’ investments. Do asset-owners have the stomach for a potentially risky roller-coaster ride with the relevant governments, slow bureaucracy, and navigating around established interests? Would beneficiaries allow them to do so?

And would the system, that appears to chain asset-owners to a heavily performance-driven approach that has hindered the development of ESG and its incorporation into mainstream, allow such brave asset-owners to survive?

Suffice to say, the debate continues and looking at next year’s calendar, so will the conferences…