ESG is facing a political and market backlash. Will it survive?

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ESG has been part and parcel of Cody Slater’s business from the start. Now, though, with the stock market cratering, ESG – environmental, social and governance – has dropped a few notches on the priority list for investors in his company, Blackline Safety Corp., he says.

Blackline manufactures and sells wearable software-enabled sensors used to detect noxious gases that could kill workers. As a safety item, Blackline’s products help a global roster of customers such as Shell PLC and Tyson Foods Inc. bolster their records in the S category – social. Meanwhile, Calgary-based Blackline has joined countless other companies in putting its own ESG programs into force, including issuing a yearly report on its progress.

This all remains important, says Mr. Slater, Blackline’s chief executive officer. But the clamour from investors demanding more stringent sustainability programs is being drowned out by a string of global crises, and worries about weakness in financial markets.

“There’s a portion of the ESG world that’s always been a bit of a bandwagon I think, and when times are good and everything’s great, it’s easy to talk about and easy to have more focus on,” Mr. Slater says.

Now, it’s not so easy. Amid a tech industry meltdown, Blackline’s share price is down by more than half since the start of the year, even as it was named to the Financial Times list of the 500 fastest growing companies in the Americas.

“I don’t know if it changes the fundamental desire from an investor standpoint, but it definitely changes the focus point – focus is off ESG,” Mr. Slater says.

The push for sustainability was a massive force in business in the first part of the COVID-19 pandemic, but in 2022, it has come under fire. As Mr. Slater says, market and social turmoil have shifted investor priorities. But ESG has become a battleground with many fronts.

Some politicians and business leaders blame the rush to carbon-free energy as a contributor to surging oil and gas prices after Russia’s invasion of Ukraine worsened an already-tight global supply situation. In addition, critics say investors in some ESG funds are being misled into believing their money is used to fight climate change and racial inequality when that’s not always the case.

Meanwhile, regulators in Canada and around the world are demanding more stringent disclosure of ESG performance, leading to higher compliance costs for companies. And some of the world’s major banks are under investigation for greenwashing.

Amid this upheaval, CEOs must keep navigating the ESG world alongside all their other responsibilities. Canadian corporations, especially large ones, have implemented extensive sustainability programs, and their boards are responsible for overseeing them. Major institutional shareholders, from pension funds to asset managers such as BlackRock Inc., still want increasing volumes of data on everything from greenhouse gases to gender diversity among directors. For some corporate bosses, a portion of their compensation is even tied to meeting ESG-related goals.

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With all of this swirling, The Globe and Mail asked CEOs: Can the push to turn businesses into forces for social and environmental good survive in a world of crisis and political polarization? If so, are we headed for a new generation of ESG?

For Don Lindsay, CEO of Vancouver-based Teck Resources Ltd., his company’s prospects still depend on improving its environmental record. As a copper and zinc miner, its output is prized in renewable energy technology. But Teck also produces steelmaking coal and crude in the oil sands, and both are scrutinized for high carbon emissions.

Even so, Mr. Lindsay sees no turning back from Teck’s sustainability push, which features a recently toughened company target to get to net-zero emissions, and donations of thousands of hectares of land for ecosystem preservation.

In the weeks after Russia invaded Ukraine, some of the company’s investors predicted the end of the push to a transition to a low-carbon global economy. “It’s on the back burner. It’s all about energy security now,” he says, summing up that attitude.

“But that changed back pretty quickly when people determined that the way to get energy security is through energy transition,” Mr. Lindsay says. “And so I think some of these global events, sad as they are, have actually strengthened the resolve of the world and accelerated the investment in energy transition.”

He says some of the skepticism that has overshadowed ESG is a reaction to the inexact science of scores that third-party ratings agencies provide for companies – and which form the basis of some exchange-traded funds. The agencies measure CO2 emissions, climate-related targets, work force diversity and a wide range of other metrics deemed to be material to a business’s risk profile. In many cases, the scores estimate how companies are protected against ESG-related risks more than they show a company’s full impact in the three areas.

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The debate burst into the public realm in May, when Tesla Inc. – the company credited with turning electric cars into green status symbols – was dropped from the S&P 500 ESG index. Tesla founder Elon Musk tweeted his displeasure with the move: ESG and ratings that measure performance are a “scam” that has been “weaponized by phony social justice warriors,” he wrote.

The company failed to make the cut after its ESG ratings fell because of a number of factors, including its lack of a low-carbon strategy and codes of business conduct, S&P explained.

Particularly galling for Mr. Musk, oil giant Exxon Mobil Corp. was added to the index, despite its carbon emissions and years of lobbying against tougher action on climate change. S&P rated Exxon Mobil’s ESG programs as acceptable for its industry.

“It is complex. There are a great many agencies who are generally self-anointed, who come up with their own formulas for measuring how you’re doing on ESG,” Mr. Lindsay says. “We do quite well. We’re number one in some indices, number two in the others that are generally highly regarded. But the complexity of all those indices, and everyone having their own priorities, could make you a bit cynical about whether the measurement is valid.”

ESG has been a factor in global markets for decades, albeit with different names, including ethical investing, responsible investing and sustainable investing. Companies have become accustomed to issuing annual corporate social responsibility reports to let investors and other stakeholders know about their non-financial priorities.

Over the past decade, the field morphed into an overlay to other corporate performance measures, to be sliced and diced into data highlighting risks and opportunities for companies and their investors. But ESG investing still occupied a niche in finance.

For the first time in years, more cash was drained from ESG-themed exchange-traded funds than invested

U.S.-listed ESG ETF monthly funds flow

(US$ millions)

$8,000

Broad ESG equity

7,000

Environment and

clean energy equity

6,000

Fixed income

Other

5,000

4,000

3,000

2,000

1,000

0

-1,000

May

Jan.

2021

May

Sept.

Jan.

2022

-2,000

United States ESG ETF Landscape

$120

240

Assets under management

(US$ billion, left scale)

100

200

ESG ETF count (right scale)

160

80

120

60

80

40

20

40

0

0

2016

2018

2020

2022

THE GLOBE AND MAIL, SOURCE: NATIONAL BANK

FINANCIAL; BLOOMBERG

For the first time in years, more cash was drained from ESG-themed exchange-traded funds than invested

U.S.-listed ESG ETF monthly funds flow

(US$ millions)

$8,000

Broad ESG equity

7,000

Environment and clean energy equity

Fixed income

6,000

Other

5,000

4,000

3,000

2,000

1,000

0

-1,000

May

Jan.

2021

May

Sept.

Jan.

2022

-2,000

United States ESG ETF Landscape

$120

240

Assets under management

(US$ billion, left scale)

100

200

ESG ETF count (right scale)

160

80

120

60

80

40

20

40

0

0

2016

2018

2020

2022

THE GLOBE AND MAIL, SOURCE: NATIONAL BANK

FINANCIAL; BLOOMBERG

For the first time in years, more cash was drained from ESG-themed exchange-traded funds than invested

U.S.-listed ESG ETF monthly funds flow (US$ millions)

$8,000

Broad ESG equity

7,000

Environment and clean energy equity

Fixed income

6,000

Other

5,000

4,000

3,000

2,000

1,000

0

-1,000

May

Jan.

2021

March

May

July

Sept.

Nov.

Jan.

2022

March

-2,000

United States ESG ETF Landscape

$120

240

100

200

Assets under management (US$ billion, left scale)

ESG ETF count (right scale)

80

160

60

120

40

80

20

40

0

0

2015

2016

2017

2018

2019

2020

2021

2022

THE GLOBE AND MAIL, SOURCE: NATIONAL BANK FINANCIAL; BLOOMBERG

That changed during the first two years of the pandemic. With economies forced into lockdown, society in general – and financial markets in particular – saw how vulnerable the world is to shocks. Executives and investors took note of how other systemic problems, such as climate change and racial inequality, present major risks that have to be dealt with.

As the climate crisis has become more acute, the transition to a low-carbon economy emerged as the top focus, forcing energy, transport and mining companies to devise goals to cut carbon emissions. That shift also helped renewable energy and other cleantech startups flourish. For investors, ESG became an asset class unto itself, with money in mutual and other investment funds topping US$2.7-trillion worldwide.

But this year, a lot of those investments have cratered as jittery markets abandoned long-term growth ambitions and turned attention to the need for investments offering immediate cash flow. In May, U.S. ESG funds suffered their first outflow of money since 2019, says Baltej Sidhu, ESG analyst at National Bank of Canada.

Yet the pullback will not change the long-term ESG focus for Manulife Financial Corp.’s asset management arm, Manulife Investment Management, says Paul Lorentz, the unit’s CEO. In fact, nearly all the investment mandates the firm bids on now demand proof of its ESG expertise and performance, Mr. Lorentz says. “It may vary a little bit by geography, but it’s becoming table stakes now in terms of what investors are expecting or what asset owners are expecting.”

Despite the market turmoil, the insurer’s investment division, which has $860-billion under management, still sees steady demand for investments that reflect more than just profit, he says. “There’s so much noise out there, but I think what matters is, are they comfortable with the companies that they’re dealing with? Are they really proud of what those organizations are trying to do to their business, to further the agenda?”

Some of that noise has come from politicians and business leaders, especially in the United States. They chafe with the machinations of ESG and its increasingly detailed disclosure and target-setting requirements. Regulators, including the U.S. Securities and Exchange Commission and the Canadian Securities Administrators, are among authorities demanding more reporting on ESG measures while they also vet corporate environmental claims to combat greenwashing. They are facing pushback from many companies and their industry associations.

Major financial institutions, such as Deutsche Bank’s DWS unit and Goldman Sachs, are under investigation for the veracity of ESG promises in investment funds. In March, the SEC hit BNY Mellon with a US$1.5-million fine for misstatements and omissions.

On the other hand, inflation and fuel shortages, partly due to international sanctions in response to Russian President Vladimir Putin’s invasion of Ukraine, have pinched consumers and helped fuel skepticism about a shift to green energy.

Darren Gee, CEO of Peyto Exploration & Development Corp., a Calgary-based natural gas producer, said some factions of society fell victim to the belief that the transition to low-carbon energy could be done quickly without having to worry about reliability and affordability. He laments how natural gas is often lumped in with dirtier forms of energy. He says it should be shipped globally to displace coal, as demand for fossil fuels remains.

“I think we were rushing into something without really thinking deeply about it,” Mr. Gee says. “It’s a rush to try and create a system of governance on the supply. This has no impact on demand. And yet it’s demand that we want to affect. Governments around the world, free societies like North America, where we have institutions that are trying to do what they can are all focused on supplies. None of them are focused on demand.”

The energy industry has been at the centre of debates over environmental impact for decades. As recently as a year ago, some institutional investors warned Canadian oil and gas producers their access to capital would be cut off unless those companies upped their games on ESG – specifically carbon emissions. A few pension and university endowment funds, such as the Caisse de dépôt et placement du Québec and Harvard Management Co., publicized their decisions to divest from the sector.

Now, with the prices of energy commodities at multiyear highs, access to capital is of little concern – much of the industry has more money than it can spend profitably by increasing production. Instead, companies have paid down debt, raised dividends and bought back shares.

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Mr. Gee says ESG has not moved on Peyto’s priority list, even as energy security and prices have blasted to the fore.

“We as a company have always been extremely focused on efficiency and as a result of being as efficient as we can be, we have traditionally led the industry in our cost structure. We’re the lowest-cost producer,” he says. “That low cost and that efficiency also flows through to environmental performance. We’re not wasteful and generally the environmental impact is worse when you’re wasteful.”

As a business concept, ESG has attracted some big-name enemies. Texas legislators passed a law last year that penalizes firms for excluding oil and gas holdings by preventing those firms from doing business with the state’s pension and investment funds. Other states, including West Virginia, are following suit. Former U.S. vice-president Mike Pence has decried ESG regulations that he said “allow left-wing radicals to destroy American energy producers from within.”

One leading light of the “stakeholder capitalism” movement has taken pains to explain he is not some kind of left-wing activist. Larry Fink, CEO of BlackRock Inc., the world’s largest asset manager, and the man credited with bringing ESG investing into the mainstream, used his annual letter to business leaders in January to send the message that he does not have a “woke” ideological agenda.

“It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. This is the power of capitalism,” Mr. Fink wrote.

So far, the U.S. has proved to be more politically polarized on sustainability issues than Canada, Mr. Sidhu says. “Most people in Canada know that our resources are more on the carbon-intensive side, and there is a need for us to at least get it down to a median on the global scale. I think [the backlash] is not going to be as pronounced as we’ve seen it in the States.”

Still, ESG is proving contentious globally as well. In May, Stuart Kirk, who was global head of responsible investment at HSBC Investment Management, made waves when he gave a speech criticizing those who make doomsday predictions about global warming and play up the finance industry’s responsibilities for combatting it.

His remarks, at the Financial Times’ Moral Money Summit, went viral and prompted the HSBC’s CEO to issue a statement saying they did not represent the views of the British financial giant, which remains focused on net-zero goals. HSBC suspended the 27-year veteran, fuelling a debate over accusations of corporate cancel culture.

Mr. Kirk resigned this past week, promising to “continue to prod with a sharp stick the nonsense, hypocrisy, sloppy logic and group-think inside the mainstream bubble of sustainable finance.”

Amid the turmoil, the onus remains on companies across industries to live up to their claims and be transparent with their reporting so investors are confident they are putting put their money where it has positive impact, and aligns with global environmental and social goals, Mr. Lorentz says. “Unfortunately there are examples out there where this hasn’t always been the case.”

Indeed, the problems ESG is supposed to address, notably climate change, still exist, and are getting tougher to counteract as the energy crisis persists. This year, the United Nations Intergovernmental Panel on Climate Change said solutions for reducing greenhouse gases are available, but it is an open question whether they can be scaled up quickly enough to meet international commitments and head off the worst impacts of global warming.

Mr. Lindsay says there is more than enough evidence. He points to the environmental devastation in Teck’s home province of British Columbia last year – the deadly heat dome and wildfires that destroyed the village of Lytton, then the “atmospheric rivers” in November that led to massive flooding in the B.C. Interior that took out roads and rail lines, and submerged vast agricultural lands.

“So that tells you something, and it just heightens our efforts. We’ve got to deal with this global problem. We have to do our share and I think our whole culture at Teck is totally committed to this,” he says.

Will ESG emerge intact from its current crisis? Most business leaders say it will, but it is undergoing a shift in thinking. Many predict sustainability will be treated as overarching best practice for all businesses rather than an asset class that competes with others for capital, and that is subject to cyclical swings.

This is part of what Martin Grosskopf, portfolio manager with AGF Investments Inc., calls ESG 2.0. “Whether it continues to be called ESG, or whether its just assumed what’s in general due diligence in risk management, that remains to be seen,” he says.

Investments in ESG generate long-term benefits and companies are not likely to dismantle their programs now that they are ingrained in corporate operations and governance. “ESG hasn’t disappeared in Europe, It’s not going to disappear from a shareholder rights perspective,” Mr. Slater says. “I think many are finding it’s now part of their culture, part of their road map, and it will continue to be so for a good period of time.”

Jeffrey Jones writes about sustainable finance and the ESG sector for The Globe and Mail. E-mail him at jeffjones@globeandmail.com.