A senior manager of the world’s largest investment firm has ‘blown the whistle’ on ESG (environment, social and governance) ‘greenwashing’, especially on supposed climate finance.

Wall Street whistle-blower

Tariq Fancy was Chief Investment Officer (CIO) for Sustainable Investing at BlackRock, managing over $9 trillion in assets.

Founded in 1988, headquartered in New York City, and with the world’s largest investment portfolio, BlackRock can move financial markets.

Hence, Fancy’s insider critique of corporate ESG pretensions — often associated with ‘responsible’ and ‘impact investing’ — has had a major impact.

It has been seen as confirming and even elaborating on longstanding criticisms of ESG ‘greenwashing’.

Rejecting ‘stakeholder capitalism’, shareholder capitalism guru Milton Friedman long emphasised that a corporation’s primary and sole duty is to maximise profits for shareholders.

Managers are legally required to prioritise shareholder financial interests above all else.

This means corporations must never sacrifice profits or their funds, however noble the cause.

Ethical or responsible actions can only be justified if they enhance ‘shareholder value’.

Thus, companies can take morally desirable actions to improve their ESG ratings only if and when they enhance profitability.

As Friedman emphasised, corporate executives have strict fiduciary responsibilities under the law in ‘shareholder capitalism’ in the US, UK and elsewhere.

Their managerial obligations and conduct thus limit potentially positive ESG impacts.

Prioritising their corporate fiduciary duties above all else, they cannot enhance social or environmental benefits without maximising returns for shareholders.

By law, social, community or national ethical duties or moral values must always be secondary.

Is green financing progressive?

Corporate practices respond to changing understandings of profit-maximisation in the medium to long-term.

With changing national and international requirements, companies may be able to maximise long-term financial gains by investing in sustainability.

Thus, investing in green transitions — e.g., renewable energy or reafforestation — can become profitable in the longer-term if the regulatory environment changes soon enough to sufficiently change incentives for long-term investments.

So, long-term profitability can be enhanced at the expense of short-term gains if conducive regulations, incentives and deterrents are introduced early enough.

Companies changing to more environmentally sustainable practices — like adopting solar panels, investing in re-afforestation, or other green initiatives — may thus become more profitable over the longer-term.

But ‘business-as-usual’ investments are still likely to yield more short-term gains in the near-term. And stock markets are more interested in short-term corporate performance, undermining longer-term profitability considerations.

Thus, short-termist corporate governance norms deter green transitions.

Do green bonds accelerate green transitions?

Larry Lohmann has shown how difficult it is to confirm that finance raised by companies issuing ‘green bonds’ is actually additional.

It is often difficult to verify such bonds are funding new projects that would not have happened anyway.

Sometimes, companies had already planned to make certain investments using conventional financing.

With ready access to such finance, they would not have issued green bonds if not for the pecuniary advantages of doing so.

In such circumstances, green bonds have the same results as conventional finance if not for the incentives to claim otherwise.

Hence, green bonds cannot claim credit for green investments and transitions if they would have happened anyway by other means.

This raises larger questions about the supposedly transformative impact of green bonds.

Companies may even obscure environmentally unsustainable or even harmful practices by bundling them together with ostensibly ‘green’ investments.

Thus, green bonds may finance certain genuinely sustainable or environment-friendly projects without changing the rest of their investment portfolios and business practices.

Stock market discipline?

Despite lacking strong supportive empirical evidence, advocates claim ESG-compliant stocks outperform non-compliant ones in the share market.

Similarly, they claim such compliance improves overall ESG indicators and contributes significantly to achieving the Sustainable Development Goals.

But there is no strong evidence that ESG-inspired stock market or corporate strategies have improved the environment, society or governance.

After all, shareholders and companies prioritise short-term financial goals over longer-term considerations, including ESG and long-term profitability.

Divestment of shares in companies which are not ESG-compliant may only have limited impact if others buy non-compliant stocks, especially after their prices have fallen.

Also, even if some investors sell their shares in companies which are not ESG-compliant, it is unlikely the stock market will  ‘green’ corporate behaviour more broadly.

Such stocks are mere drops in the ocean of wealth and finance, and one cannot realistically expect the tail to ‘wag the dog’.

In 2021, the world economy had $360 trillion worth of wealth, with nearly $6 trillion in private equity.

Disciplining companies

Divestment means selling shares and thus losing ‘voice’ in company governance. But for shareholder engagement, it is necessary to retain stock ownership.

Holding stock gives shareholders voice which can be used to try to pressure companies to be more ESG-compliant.

Without financially damaging effects for its reputation and share price, a company would not be compelled to become more ESG-compliant.

Only significant stock price collapses — following massive share divestment due to reputational damage — are likely to motivate companies to become ESG-compliant.

Undoubtedly, adverse publicity for particular companies hurts their stock prices, at least temporarily. And this may force companies to improve their behaviour.

But such success implies a ‘name and shame’ approach — not ESG-compliance — can be effective.

And while some share prices may be more sensitive to adverse ESG publicity in some societies, there is no strong evidence this is true everywhere. Nor is there any strong evidence that systematic ESG reporting has generated desirable outcomes in most societies.

Divestment may not strongly affect company profitability or share prices. But actions such as consumer boycotts directly influence company revenue and financial performance.

This may prompt strong corporate responses due to their impacts on companies’ ‘bottom lines’.

(Jomo Kwame Sundaram was an economics professor and United Nations Assistant Secretary-General for Economic Development.)