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Being Good and Playing Nice: The Holistic Approach to ESG Investing

In January of 2018, BlackRock CEO Larry Fink sent a letter to the chief executives of the world’s largest companies, informing them that making a profit was not their only job. They also had a responsibility to “serve a social purpose,” a major departure from the prevailing notion that management’s primary focus must be to maximize shareholder value.

Fink followed up in his annual letter to shareholders in January of 2020 with a warning that the climate crisis would fundamentally change the finance world. BlackRock would therefore not invest in companies with high “sustainability-related” risks. The firm would pull investments out of coal companies, create new ETFs that did not invest in fossil-fuel stocks, and vote its shares against managers who were not combating the climate crisis. These were significant statements coming from the CEO of an investment firm with $6 Trillion in assets under management.

Fink’s letter has actually had a negative impact on furthering his stated goals. Instead of focusing on companies being responsible corporate citizens, it has created a cottage industry of consultants and ratings agencies, which has resulted in most companies simply gaming the ESG system. On the other hand, BlackRock has made lots of money selling so-called ESG funds to investors. It is not unreasonable to question whether the ESG push is sincere or merely taking advantage of an opportunity to get more investment dollars from socially conscious investors,” said Rashida Salahuddin, President of The Corporate Citizenship Project, a think-tank focused on bringing a data-driven view to corporate governance issues.

One effect of BlackRock’s commitment is that the number of ESG funds available to investors has ballooned. Where once there were just a few funds that avoided investing in certain companies (e.g. tobacco or oil companies), now there are literally hundreds of funds based on “holistic” indexes that try to assess every attitude and action of a corporation and cook up a metric that might be called simply a “goodness standard.”

S&P Global, one of the industry’s top ESG index producers, has a Corporate Sustainability Assessment document that is more than 250 pages of densely-packed prose about the questions it asks companies, what sorts of information and data S&P wants, and, finally, how that information is used in S&P Global ESG scores. Those scores are materially important to the companies being rated by S&P because inclusion in an index boosts liquidity.

“ESG ratings have become like a credit score for publicly traded companies,” said Bryan Junus, Chief Analyst for The Corporate Citizenship Project.

“ESG ratings are no longer merely something to highlight in a press release. They directly impact a company’s liquidity and therefore its operational viability. As a result, it is troubling to see ISS ESG and S&P seemingly refuse to be 100% transparent to investors and companies with their rating methodology.”

Institutional Shareholders Services, while not an index creator, provides corporate managers and shareholders with recommendations for voting on proposals that may be part of a company’s annual shareholders’ meeting. Its 2022 Proxy Voting Guidelines only runs to 75 pages because it does not provide the same level of detail that S&P Global provides.

Where S&P outlines how companies must report (among other things) how well they match up with the Greenhouse Gas Protocol and defined scope 1, 2, and 3 emission levels, ISS’ approach is less well defined. ISS “generally recommends” that shareholders vote in favor of resolutions “requesting that a company disclose information on the financial, physical, or regulatory risks it faces related to climate change on its operations and investments or on how the company identifies, measures, and manages such risks.”

ISS also suggests generally voting in favor of “proposals requesting a report on greenhouse gas (GHG) emissions from company operations and/or products and operations” except in certain circumstances. And ISS recommends voting on a case-by-case basis on “proposals that call for the adoption of GHG reduction goals from products and operations.”

According to The Corporate Citizenship Project’s Salahuddin, these measures have fallen short.
“BlackRock, ISS ESG, and S&P are all profiting off of ESG and yet none seem to be holding themselves to their stated values. Fink’s polluting jet, ISS’s seemingly all-white management team, and S&P’s clearly political attack on Tesla are indicative of a lack of sincerity on the part of ESG activists. How can American businesses and investors be expected to sacrifice investment returns at the altar of ESG when the proponents of ESG refuse to do the same?”