Interests in ESG investing continues to mount. There are now $35 trillion of assets under management that purports to take such factors into account. What this means is that investors and corporates are increasingly engaged in an ESG conversation. Such conversations might occur in quarterly analyst earnings calls where ESG topics are now represented on 25 percent of all calls, up from near zero only a few years ago. Other conversations occur in private, between private equity investors or activists and management. These conversations are also occurring between asset managers and asset owners who seek to align their respective strategies. ESG conversations are a challenge, however, because people are coming into the ESG space with diverse histories, and the implementation of ESG investing within the investor and corporate community varies widely. One flavor of ESG investing is focusing on separating good from bad companies. They want to avoid investing in weapons, avoid gambling stocks, pornography, or gaming. Other companies are looking to avoid investments that undermine racial justice or undermine equal rights for LGBTQ. The list of rights and wrongs is long and it's growing. While it's certainly possible to score companies on these practices, most firms aren't entirely right, entirely wrong. Much more often, we have to weigh the good against the bad. How do we weigh ESG factors? How do we combine emojis and financial data? In the conversation on ESG, there are two approaches to this fundamental problem. If the audience wants to know about rights and wrongs, you don't combine scores or weight; you list the rights and wrongs of concern to your investor. However, if your audience cares about ESG not based on ideology, but based on economics, you've got to present that audience with a business case. Are the Chief Sustainability or Responsibility Officer sufficiently skilled in budgeting and enterprise risk management to actually undertake this? Do the communities and government affairs teams in the company know how to defend the business case for their activities? Importantly, they have to do this using the same tools and KPIs as the Chief Operating Officer, the Chief People Officer. I always find it so ironic that the sustainability teams who go around lecturing everybody about the importance of listening to their stakeholders don't make the same effort with their own financial teams. The same challenge, of course, can be leveled at the financial teams. Larry Fink, the CEO of BlackRock, has challenged the CEOs of companies in which he invests to present their plan for a net-zero strategy and the monitoring and incentives behind that plan. He similarly previously asked for details on the link between stakeholder concerns and the long-term strategy of the organizations in which he invests. How many CEOs, CFOs, and investor relation teams can rise to that challenge? How many are looking for help? Often, the best ESG conversation that can occur today is where both the sustainability and the finance teams constructively engage together in ways to identify the data, the strategies necessary to meet that challenge, and to create value from enhanced detention and engagement on ESG factors. Yes, climate change is an existential threat, but what assets will be stranded? Over what time frame? How are the assumptions about the future price of oil or gas baked into long-term planning at the corporate level? What portfolio of investment options is being made in alternative energy or green technologies? How are they being evaluated? Which ESG factors impact which revenue cost or efficiency levers over what time frame? How do they impact multiples, return on invested capital, or other's end-state financial measures? Such conversations drawing both sides rather than just spinning in circles or devolving into acrimony regarding different assumptions over the purpose of the corporation, or whether the entire ESG movement we're discussing is a fad. There's a lot of debate around that question today. That controversial argument that ESG is a fad is making the rounds, including most notably from BlackRocks former head of sustainable investing, Tariq Fancy. Fancy and other authors have recently written about the ESG bubble, the perils of heroic accounting, the dangerous allure of win-win strategies, or the deadly distraction of the ESG movement, even the complicity of corporate social sustainability. All of these critics make good points about the imperfect nature of ESG investing and the ESG conversations that have occurred to date. They all highlight the data is bad. They all highlight that there's a rush to low-fee tracking funds. They all highlight the immense gap between the $50 trillion needed to address climate risk and the funds that have actually been deployed to date. The critics are pessimistic about the possibility of overcoming conflicts of interest among asset managers, entrenched Boards of Directors, and a growth above all mindset. We could all learn from a thorough reading of those critiques, many elements of which are entirely fair and accurate. Where they land, however, is in my opinion more questionable. Most of these critiques conclude that the only viable path forward to address ESG issues is government regulation. We need a tax on carbon, a standard for universal human rights. We need to regulate the psychological environment of workplaces. We need better customer protection laws. We need to enforce free, prior and informed consent. We need better corporate governance. These are all laudable goals for which many international civil society activists and politicians have worked for decades. However, one only has to turn to the dispirited reflections of a former UN, World Bank, WTO or national government policymaker to recognize that the only strategy more hopeless than harnessing the power of capitalism to fix itself is a strategy of waiting for the government to do it. Many of the same arguments as to why corporate and financial actors are incapable of addressing ESG impacts also apply to government policymakers. Not their enforcement power, but their ability to agree on what to enforce. Even if they could surmount this obstacle, we'd still need to harness the power of capital markets because government simply don't have the $50 trillion of capital necessary to achieve net-zero emissions. Another way of thinking about this is that ESG isn't a distraction; it's a movement. When a movement begins, it's a lonely journey led by an eccentric challenging the status quo. Over time, successful eccentrics like Ed Freeman, the father of stakeholder theory, or James Gifford who first coined the term ESG while working for the United Nations, they are embraced by followers over time. Freeman and Gifford have been joined by many others over time who question shareholder primacy. They accept boundary conditions to the theory of financial market efficiency. Together, members of this movement explore the idea that attending to certain ESG factors of interests to a firm's stakeholders could actually be financially beneficial and consistent with managers and investors fiduciary duties. Both stakeholder theory and ESG critically recognize that in the words of Gifford, you get more bees with honey. by offering the promise not just of moral or policy penalties and sanctions for bad behavior, but financial rewards for good, it's easier to attract more people to your movement. As you do, new tools and new data will be introduced to improve the precision of the theoretical challenges and the empirical analysis. Evidence will accumulate. A new generation will arrive when the conventional wisdom of shareholder primacy is no longer universally accepted, but it's contested. As Ed Freeman, father of stakeholder theory recently noted, we're perhaps in the fifth inning of this movement. Tariq Fancy notes that the optimists who believe ESG investing will fix capitalism are far ahead of themselves. I and Ed Freeman agree, there's much work ahead. To quote James Gifford, "ESG is a journey, we're all on it together. If all goes well, we'll never reach the destination. Over time, it will become integral to everything we do." The question that faces us today and face Tariq Fancy as well is how do we respond to the length of the road ahead. Do we throw up our hands and walk away? That was Tariq Fancy's choice. He left BlackRock. He quit the movement. Do we clamor for government to solve the problem it has neglected for decades? Do we protest and demand divestment that makes us feel pure and righteous that has limited impact? Where's the evidence that any of those strategies, which we've tried for decades, will actually work? Or alternatively, do we draw energy from the modest progress made over the past few years in the ESG movement and prepare for the coming challenges in the hope of further accelerating our progress on the long journey?
