Time to separate the E from the S and the G

With climate change policy weakened, revamping ESG to ward off the worst effects of global warming is now more critical than ever.

Back in 2018, the UN’s Principles for Responsible Investment commissioned the Inevitable Policy Response to help investors assess risks related to climate change. “IPR contends that governments will be forced to act more decisively than they have thus far, leaving financial portfolios exposed to significant transition risk,” it states on its website.

But after three major developments in the past three weeks, it seems that policy response will inevitably be delayed – if it arrives at all.

It began with the G7 summit in Germany where, on 28 June, the leaders of Canada, the US, UK, France, Germany, Italy and Japan backtracked on their commitment to end public finance of fossil fuel projects, a pledge they made last year at COP26 and one they re-affirmed as recently as May.

Two days later, the US Supreme Court handed down a ruling that severely restricts the Environmental Protection Agency’s ability to limit power plants’ greenhouse gas emissions. And just last Wednesday, the European Commission’s proposal to classify nuclear power and natural gas as ‘green’ energy, was approved by the European Parliament in a vote of 328-278, a decision the New York Times characterised as “likely to reverberate far beyond Europe’s borders and set a benchmark that could be replicated around the world”.

Time will tell which of the three decisions will prove most damaging – though right off the bat one can see how watering down the EU Taxonomy will weaken the green credentials of Article 8 and 9 funds. What’s immediately clear is that none of this is good news for the energy transition.

This weakening of government policy – combined with growing instances of greenwashing and the IPCC’s April warning that we’re running out of time to limit global warming to 1.5 degrees Celsius – urges us to revisit an important question: is it time to unbundle environmental criteria from social and governance factors to counter the worst effects of climate change?

There is no doubt ESG has been critical in driving corporate behaviour in a more sustainable direction, but there is legitimate doubt whether bundling together criteria as disparate as greenhouse gas emissions, cybersecurity and worker safety is the best way to mobilise the private sector in the fight against climate change.

One of the challenges companies, industry, and fund managers point to with regards to ESG reporting and compliance is the lack of standardised benchmarks and difficulty in measuring related impacts. This was clearly demonstrated by a study the CFA Institute published last August, compiling ESG ratings from MSCI, S&P Global, Sustainalytics, the Carbon Disclosure Project, Institutional Shareholder Services and Bloomberg. Overall, it found the results to be “conflicting and contradictory”, noting that MSCI’s correlation with both S&P and Sustainalytics is below 50 percent.

It’s high time, then, to assess the E separately from the S and the G. Doing so will bring more transparency and more clarity both for those required to collect and report on environmental and climate-related data and those responsible for assessing it.

This is particularly relevant for infrastructure investors – and not just because they are at the forefront of building new energy transition infrastructure. As the United Nations Office for Project Services pointed out, infrastructure accounts for 62 percent of total greenhouse gas emissions.

“This asset class is the single most vulnerable to climate crisis. The very thing that as investors we like about infrastructure – it’s large and permanent, expensive and time-consuming to build and therefore protected against competition – these are the very reasons this asset class is so exposed,” Bill Green, managing partner at Climate Adaptive Infrastructure, told us a few months ago, underlining the dangers of business as usual.

For all those reasons, infrastructure investors – and the private sector in general – would benefit from a framework enabling them to zero in on environmental criteria.

The S and the G are a key part of sustainable investing, which goes beyond climate change. But climate change is a legitimate emergency – it’s time we treat it as one.