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While the majority of investors agree on the benefits of sustainable investing, a famous voice in the US recently shared some opposing views: Elon Musk, the infamous tech billionaire and key player in the electric vehicle scene, positions himself as a vocal critic of ESG. While he only represents a small minority, his words can reach large audiences. So, it is important to have an objective look at his claims to clear up any confusion and debunk potential falsehoods.
Elon Musk argues that Environmental, Social, and Governance (ESG) indicators have become overly politicised and an untrustworthy metric for sustainability. The reason for this claim is that tobacco firms, notorious for causing cancer, have scored higher on ESG in several sustainability indices, while Tesla lagged behind. At first glance, this seems surprising: companies selling addictive products linked to a laundry list of health conditions are rated more positively on ESG factors than an electric car manufacturer? You wouldn’t be remiss to think that something doesn’t add up.
However, Elon Musk’s discourse clearly demonstrates a lack of understanding of some of the fundamental principles of ESG.
First, it is important to clearly differentiate between ‘ESG’ and ‘Impact’. ESG scores by providers, try to enumerate the key environmental, social, and governance risks associated with a company’s activities and its value chain. These risks can have a financial impact on the companies. Such ESG scores put a company in a broader context and should provide investors with a concise metric to consider the effects of a company’s activities on its stakeholders (i.e., employees, shareholders, and end-users). This means that ESG-rating companies tend to focus on company disclosure on ESG topics, such as the existence of health & safety policies, recycling programmes, renewable energy purchases, board diversity, or significant controversies around ESG topics.
These ESG scores don’t necessarily put the emphasis on the impact of a firm’s final products and services; otherwise, tobacco companies would not feature as prominently in the rankings. This is also the distinct difference between ‘ESG scores’ and ‘Impact’. The former looks at the ESG risks related to the generation of a product or service and the company’s management response to it. The latter looks at the product or service’s impact on stakeholders. These tobacco firms, for example, might have implemented the most stringent health & safety policies, abide by solid ethics principles, and have an extensive environmental management system, granting them a high ESG score. Nevertheless, these companies’ impact score is clearly far lower, as, according to the WHO, its addictive products kill more than 8 million people on a yearly basis. Tesla, on the other hand, is not scoring that well on ESG (based on the S&P methodology), due to its inadequate employee health & safety practices, allegations of discrimination, and the safety of its end-consumers.
Backed by European regulation, asset managers need to make a distinction between having sustainable investment objectives (= Impact) and sustainable investment characteristics (= more ‘traditional’ ESG) in their product offering. Naturally, both principles are complementary. With the EU Taxonomy, the regulator tries to define and identify these impact activities, and the SFDR regulation tries to prevent the conflation of ESG and impact, by clearly splitting objectives and characteristics. A recently launched proposal by the European Commission on extra-financial information (CSRD), pushes companies to carry out a double materiality analysis; determining which ESG risks can be material both in terms of their implications for the company’s financial value, as well as the company’s impact on the world at large.
All this is to show that a truly sustainable and responsible asset manager needs to look both at the externalities of a company’s activity, bolstering the positive and diminishing the negative ones, and also encourage sustainable investments through investee companies’ products and services. When discussing the impact of an asset manager or asset owner, the organisation’s impact on the investee companies should be analysed. Indeed, the changes that an asset manager can induce with its investee company through active stewardship are both intentional and measurable with an impact on the real economy.
Global challenges and adequate solutions to these problems cannot always be represented by a ranking, a single score, or an index. The large discrepancy between ESG scores of different data providers reinforces this statement. Individuals who claim they are able to do so prey on investor confusion.
We believe that our active, sustainable, and research-driven approach can properly navigate these challenges, clear up any confusion, and identify the right opportunities for our clients.