Updated: Mar 1, 2022
Author: Nathalia Turincev
Bio: Nathalia Turincev is a master student at the Graduate Institute. She is passionate about social justice and environmental protection, the energy transition, circularity, and food systems.
Editor: Khaliun Purevsuren
“There seems to be a broad consensus in the business world that, with governments having failed to rise to the climate challenge, the private sector needs to pick up the slack,” read a Financial Times article from November 2021 as COP26 got into full swing in Glasgow. As if echoing this statement that same week, the Glasgow Financial Alliance for Net-Zero (GFANZ) ambitiously announced that the private sector commits $130 trillion of assets towards net-zero transition. Such capital is envisioned to fill the funding gap created by the governments in times of their large debt surge due to COVID-19 pandemic, which made them fall short of the needed funds to finance low carbon transition. However, the private sector’s eagerness to lead the race to net-zero raises important questions about their motives, legitimacy, and accountability when making big promises. Particular attention should be paid to the question “are ESG investments & its incentives by the private sector enough to enable the clean transition?” This is not referring to whether the numbers add up, whether ESG funds are big enough for the challenge, the lack of regulation and definition on what qualifies as ESG or whether greenwashing has plagued the ESG concepts. The main focus is on whether the private sector can generate a strong enough force to tilt the balance in favour of a transition.
The logic behind ESG investing is that it raises the cost of capital for polluting companies that will eventually have less financing to operate, but will reduce the cost of capital for “green” companies. It assumes that as environmentally harmful companies become less attractive to investors, they will be incentivised to reduce their emissions whereas environmentally mindful companies will gain access to better credits and be attractive in the long run despite low returns in the beginning. However, the force behind this logic is not likely to be strong enough to incentivise transition for two reasons.
1) Issue with coordination and cooperation:
If an investor divests from a polluting company, other buyers (the ESG “free riders”) still remain for that company in the short run at least. For example, ExxonMobil, Chevron, BP, Royal Dutch Shell, Total and Eni have sold $28.1 billion in assets since 2018 and are expected to sell an additional $30 billion worth of assets in the near future. In many cases, “brown” assets are simply being passed from one investor to another. ESG investing can only have a substantial impact if all funds, asset managers and banks are on board with the ESG agenda. Unfortunately, this is far from being the case as of today.
2) Net-zero transition needs to be quick.
The transition towards net-zero needs should have started years ago to limit the consequences of global warming, so we must act quickly now. However, there are reasons to question whether the shift from “brown” to “green” assets as promised by the private sector will happen fast enough. Although the private sector favours market incentives over regulations, as they allow for an efficient allocation of resources, resource allocation can take time. Additionally, market failures can also prevent negative externalities from being internalised.
The arguments can be even further and more complex, but overall, the above-mentioned arguments suggest that the private sector impetus through ESG is not strong enough to alter the energy status quo and lead the energy transition in the short to medium term. Although the private sector is becoming more conscious of the climate crisis, I share the view of Tariq Fancy (BlackRock’s ex-first global chief investment officer for sustainable investing) that the ESG is a “dangerous placebo” that distracts us from solutions that fit the scale of the climate problem. It merely gives the impression that things are changing while delaying meaningful actions such as government regulations i.e. the carbon tax.
A carbon tax is able to directly affect the profits of polluting companies, forcing them to reduce their emissions to remain profitable. The tax has a similar effect to raising the cost of capital as ESG envisions. However, the tax is a more stringent way to raise the cost of capital because the effects are immediate, and the free-riding issue is eliminated. The main takeaway is that although this does not mean private sector’s ESG investing does not have an important role to play in clean transition, it is neither a panacea to the climate crisis nor a substitute to the state regulations.