The ESG experienced a tormented year 2022 – 01/04/2023 at 16:45

In Europe, the debates mainly revolved around the definition of sustainable finance during the second half of 2022. In question, the SFDR (Sustainable Finance Disclosure Regulation), the initial vagueness of the contours of the concept of too much leeway for asset managers. (Photo credits: Adobe Stock – )

( – The ESG seemed to have a clear future. But the year 2022 will have been that of a difficult awakening for an approach that thought itself ready to change the world. With the accumulation of assets, and the conversion of many investors to this approach, ESG has been particularly scrutinized by the market over the past twelve months. And, because of the lack of uniformity and of a precise definition, numerous debates have erupted in areas as varied as war, extra-financial rating, or even the politicization of the financial sector. To the point of questioning the relevance of ESG. A brief overview of a year full of debates.

The Orpea case highlights the weaknesses of ESG ratings

The questioning of ESG began quickly in 2022, with the Orpea affair. In January, the publication of the book Les Fossoyeurs rocked the French operator of retirement homes on the stock market. Journalist Victor Castanet accused him in particular of mistreating his patients.

However, Orpea was among the best rated in its universe in terms of ESG before the start of this affair. In the financial world, it has led many voices to question the relevance of extra-financial ratings. As a result, the European Commission’s Directorate General for Financial Stability (DG Fisma) has launched a public consultation on the ESG rating market in Europe. Verena Ross, president of Esma, also announced that the European regulator wanted to supervise extra-financial agencies.

In an interview with Newsmanagers, researcher Florian Berg, associated with the MIT Sloan School of Management, explained the various flaws in the current extra-financial rating, such as the discrepancies in data and methodologies, or the gap in the time between a note modification by the agency and its consideration by the manager.

The war in Ukraine renews certain questions

The following month, the criteria for ESG funds were again criticized following the invasion of Ukraine by Russia. Should or can you invest in defense sector stocks when you are an ESG fund? Newton IM chief executive Euan Munro advocated it, arguing that national security was part of a “common good”.

On the sanctions side, and the divestment of companies exposed to Russia, ESG investors have been slow to make up their minds. They found themselves having to arbitrate between defending international law and human rights, and protecting the Russian population from the consequences of the withdrawals of certain companies, particularly those in the food sector.

This problem of exposure to dictatorial regimes goes beyond the simple case of Russia. Two NGOs (Inclusive Development International and Altsean-Burma) in March accused 344 ESG funds of being invested in 33 companies that provided weapons, technology and communications to the ruling Burmese military junta. Total amount of exposed outstandings: $13.4 billion.

ESG is becoming a political subject in the United States

Geopolitics isn’t the only area troubling ESG. Domestic politics is perhaps more likely to sow discord. Indeed, if asset management is accused of not being green enough in Europe, it is quite different in the United States. The Republicans have started a battle there against ESG investing, which they have described as “cancer”, “fraud” or even “woke capitalism”. Some Republican states have simply decided to break off their commercial relations with managers practicing the ESG approach. This mainly concerns the pension funds of Florida, Louisiana, Utah, Arkansas, or even Kentucky, which have terminated the mandates entrusted to BlackRock, for more than 3 billion dollars in assets. Conversely, the head of New York City’s public pension funds felt that BlackRock was not doing enough for the climate!

The subject of ESG has even come to become a campaign argument during the mid-term elections. The Republicans have promised to hear the heads of the major American management companies (BlackRock, State Street and Vanguard) as well as Gary Gensler, the Democratic chairman of the American regulator the SEC, about ESG investments. However, they lost the majority of the House of Representatives by five seats.

Faced with these political onslaughts, the two American giants of passive management, Vanguard and BlackRock, have decided to follow different lines of defense. The former played it safe by pulling out of the Net Zero Asset Managers Initiative manager alliance. The second began a balancing act by reminding the Republicans that he was still heavily invested in American energy, but that taking into account climate risks was necessary for certain clients from the point of view of future returns. This approach obviously did not please the co-chief investment officers of Bluebell Capital Partners, who asked Larry Fink to resign. “The contradictions and apparent hypocrisy of BlackRock’s actions have…politicized the ESG debate,” they wrote in a letter to BlackRock’s CEO and Founder.

The Great Collapse of the Article 9 Funds

In Europe, the debates mainly revolved around the definition of sustainable finance during the second half of 2022. In question, the SFDR (Sustainable Finance Disclosure Regulation), the initial vagueness of the contours of the concept of too much leeway for asset managers.

The recent clarification by Esma, the European regulator, of what an article 9 categorized fund is has caused a massive declassification of funds to article 8 or even 6. This has mainly affected passive funds which follow indices aligned with the Paris Agreements (PAB – Paris-aligned Benchmark) and CTB (Climate Transition Benchmark). The main management houses were the first to backtrack, such as BlackRock, Amundi, Pictet AM, BNP Paribas AM, and DWS. Medium-sized players like La Française AM and Carmignac have also followed suit.

This hitch prompted the European Commission to launch an evaluation of this regulation in 2023.

In the rest of the world, Anglo-Saxon regulators have decided to tighten their ESG and sustainability rules. The United Kingdom has thus launched a consultation on its future sustainability standards for funds. The Financial Conduct Authority, for its part, will now verify that management companies comply with its ESG principles. In the United States, the SEC intends to tighten the reporting rules for ESG funds. The American regulator has also modified two rules, including the naming rule, in order to require funds bearing the term ESG to invest at least 80% of their assets in accordance with the management proposal contained in its name. This American rule impressed Esma, which also launched a consultation on the use of ESG in the names of funds. Finally, the Indian and Chinese regulators have also started projects to strengthen the transparency of green financial products.

Sanctions still limited in terms of greenwashing

Competitive pressure among asset managers to meet the growing demand for sustainable finance products has pushed some players to take too many marketing risks. This has led the public authorities to take action in order to protect consumers. In Germany, the police raided the offices of Deutsche Bank and DWS as part of their investigation into fraud on ESG funds, leading to the resignation of Asoka Woehrmann, in charge of the German bank’s asset management professions and CEO of DWS. The management subsidiary was accused in 2021 by a former employee of having lied about the extent of its green investments. The house has since been the subject of a complaint by the consumer protection agency of the state of Baden-Württemberg for misleading advertising concerning “supposedly sustainable investments”.

In the United States, the SEC imposed pecuniary sanctions on leading players. BNY Mellon Investment Advisor, a subsidiary of BNY Mellon, was fined $1.5 million for misleading claims about its funds that use ESG criteria in stock picking. Goldman Sachs AM paid him $4 million to put an end to an investigation into the management of two funds and a mandate marketed as meeting ESG criteria.

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