What's Behind the ESG Investing Backlash in the United States?

ESG (environmental, social, and governance) investment, which has dominated the financial markets of developed countries, is now facing a backlash. In particular, there is a growing movement to halt excessive ESG investment in the United States. The head of BlackRock, the world's largest asset management company, said, "I don't use the word ESG any more."

In recent years, financial institutions worldwide have posited ESG factors, such as climate change compliance and human rights, as absolute investment criteria. Companies are now required to promote ESG activities to receive funding from banks. Therefore, companies that fail to meet ESG standards are now excluded from investment and financing opportunities. Such asperity runs counter to the original ESG goal of ensuring diversity.

The best example of this would be decarbonization. Financial institutions have pulled their money from coal and oil mining and constructing power plants that use them. These institutions claim that fossil fuels are not consistent with decarbonization. This has caused a global decline in investment and financing for resource development. Fossil fuel prices then skyrocketed when demand surged due to post-pandemic recovery and Russia's invasion of Ukraine. 

A Backlash Sweeping the Global Financial Markets

An anti-ESG movement has emerged in the US, where inflation has accelerated due to soaring energy prices. In December 2022, Vanguard Group, a major US asset manager, announced its withdrawal from the Net Zero Asset Managers Initiative (NZAM). ESG investment trusts grew rapidly by attracting funds off the back of the investment trend. However, the momentum has shifted, and they are now experiencing significant outflows this year in 2023.

Political rivalries in the US have also played a role. Governor Ron DeSantis of the southern US state of Florida, currently seeking the Republican nomination for the next presidential election, opposed the environmental policies promoted by Democratic President Joe Biden. In May, Florida passed an anti-ESG law imposing comprehensive restrictions on ESG investment activities. Among other things, the law prohibits the consideration of ESG factors when issuing municipal bonds.

The legislation also requires that investments and loans by the state's pension fund place the highest priority on returns. Furthermore, executives and investors cannot incorporate ESG criteria such as climate change and diversity into their investment evaluations. It was also decided that banks with ESG investments would be excluded from depositing public funds.

Failure to Meet Shareholder Interests

What's behind the spread of anti-ESG, particularly in the United States? A growing number of critics argue that the primary mission of investment is to maximize profits for investors and shareholders. Therefore, investment returns should not be sacrificed in the name of solving social issues. For instance, institutional investors that have made ESG investments despite skyrocketing fossil fuel prices have failed to generate sufficient profits to meet shareholder expectations.

I recently investigated a domestic investment fund that engages in ESG investment. The fund manager argued that Japan should achieve 100% renewable energy as soon as possible. I replied, "Even aiming for carbon neutrality by 2050 may be difficult." 

With a straight face, he said, "We cannot take too long." Otherwise, he warned, Japan will get another "Fossil of the Day" award at the Conference of the Parties [COP] of the United Nations Framework Convention on Climate Change [UNFCCC].

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How could the manager of an ESG fund, which is entrusted with such vast amounts of investors' money, have such limited knowledge of energy? After all, energy forms the basis of industry and people's livelihoods. Feeling shocked, I realized just how superficial ESG investment was.

An Over-Simplistic Approach

I have heard a similar story from the head of a major energy company. At a meeting hosted by the Japan Business Federation, he emphasized the difficulty of decarbonizing electric and gas utilities. Attendees, however, demanded the adoption of 100% renewable energy sources. He was stunned. It's hard to believe that even the executives of major companies could be so simplistic in their thinking.

Decarbonizing the vast electric utility industry will require inordinate amounts of money and time. Even Europe, the leader in global decarbonization, has failed to indicate a process for decarbonizing the electric utility industry. Japan is the only country drawing up a detailed blueprint for the transition.

A Return to Rationality

The anti-ESG movement is an opportunity to correct unrealistic investment decisions. Of course, the development of advanced technologies for decarbonization is important. However, developing countries now emit more than twice as much greenhouse gases as developed countries. Therefore, strengthening measures in developing countries is crucial to prevent global warming.

Licensing Japan's advanced coal-fired power generation technology can be effective in this respect. ESG investments that put a blanket ban on the export of coal-fired power are not. 

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(Read the article in Japanese.)

Author: Shigeyuki Ii