Challenges to ESG Investment: Who’s Pushing Back and Why?

Hong Kong Economic Journal

13 Oct 2024

The rapid rise in Environmental, Social, and Governance (ESG) investment in recent years has become a hot topic in the international financial market. Born of increasing public concern over climate change, social inequality, and corporate governance issues, ESG investing emerged with the aim of achieving sustainable development by integrating environmental protection, social responsibility, and corporate governance into investment decisions. This approach not only places emphasis on financial return but also focuses on the long-term impact on the environment and society, striving to create a social and environmental win-win situation while pursuing economic benefits.

Despite its appeal as an investment concept and the support from many investors and enterprises, ESG has been plagued by objections and challenges. So who are the opponents to ESG investment and what are their reasons for opposition? Underlying this chorus of opposition are not just suspicions about the existing rating systems and their transparency but also apprehensions about conflicts between short-term market gains and long-term goals. Getting a grasp from multiple perspectives of the opposing voices is conducive to enabling various stakeholders to have a better understanding of the complexities and obstacles facing ESG investing.

Waves of resistance on American soil

The anti-ESG movement in the US has been receiving growing attention in recent years. While ESG investing has garnered significant support and development worldwide, it faces considerable resistance and challenges within the country. First, in terms of the federal government’s view, the Donald Trump administration took an expressly anti-ESG investment stance, arguing that over-intervention in market freedom might undermine the competitiveness of American enterprises. During Trump’s presidency, the Department of Labour (DoL) and the Securities and Exchange Commission launched a series of measures to limit the integration of ESG factors into pension plans and other investment funds. In 2020, for example, the DoL released the Financial Factors in Selecting Plan Investments rule, which requires the Employee Retirement Income Security Act of 1974 fiduciaries to put first the economic interests of the plan in providing financial returns, thus restricting the application of ESG factors in investment decisions.

Apart from policy changes at the federal level, some state governments have also actively participated in the wave of resistance to ESG. For instance, conservative states such as Texas and Florida are strongly opposed to ESG investing. The governments of these states believe that ESG investment could jeopardize the future prospects of the energy sector, particularly oil and natural gas companies. Consequently, anti-ESG laws and policies have been introduced in these states to curtail investment by state government pension funds and other public funds in ESG products and projects. A case in point is the Senate Bill 13, passed in Texas in 2021, to prohibit state government agencies from investing in financial institutions that limit commercial relations or refuse to do business with fossil fuel companies. The bill aims to protect the oil and natural gas sectors in Texas and prevent investment drain caused by ESG-related policies.

Apprehensions of investors

Besides the governments, fierce opposition to ESG investing comes from the energy sector, especially oil and natural gas companies. The reason behind this is that such investments will increase their operational costs and hamper their business development. As one of the largest oil companies in the world, Exxon Mobil Corporation has been an openly opposing voice against ESG investing. In the opinion of its senior management, overemphasizing environmental and social factors could threaten the company’s profitability and returns for its investors. Chevron, another major oil company that takes a similar stance, has repeatedly expressed its concerns about ESG investing at its annual general meetings, in the belief that the related criteria may harm its core business.

While ESG criteria are gaining more recognition and broader implementation, opposition still exists in regions dependent on conventional energy and resource-intensive industries. Much of the opposition from traditional sectors boils down to the following aspects: stringent ESG criteria might negatively impact the economy and employment, or they could incur additional compliance costs, thereby compromising corporate profitability.

In general, financial investors are concerned that ESG criteria may limit their investment options and could affect their long-term returns. There is conflict between short-term pressures of the market and long-term ESG investing goals. More often than not, the capital market concentrates on quarterly financial returns and short-term performance, while ESG investing targets long-term sustainable development. This conflict leads some investors to doubt the true results of ESG investing, leaving them with the impression that it cannot satisfy short-term market demands.

Another issue constantly raised by ESG opponents is the controversy over the ESG rating system. Among the many rating systems available today, standards and methodologies vary significantly. The starkly different ratings under various systems for the same company inevitably cause puzzlement and doubts in the minds of investors. For example, Tesla scores a relatively high ESG rating in the electric vehicles category from MSCI, mainly for its contributions to innovation and sustainability. However, the company receives a rather low rating from Sustainalytics due to its problems with governance and social responsibility—working conditions and supply chains, to name just a few.

Since ESG ratings rely on information and data voluntarily disclosed by companies, there may be issues with information quality and transparency. Although Walmart has published detailed ESG reports, investors cannot help but question the accuracy and reliability of the data because of the lack of independent verification. Some companies may selectively disclose their ESG-related information, leaving out the unfavourable bits. When it comes to the transparency and independence of the rating system, some investors query the fairness of the ratings given the potential conflict of interest among the rating agencies.

Policy guidance as the first step

In the face of continuous waves of resistance against ESG, governments looking to advocate for ESG practices should take various measures to address and resolve related problems. First, incentives for good ESG practices should be provided for enterprises. To encourage corporate participation, tax concessions and other economic incentives can be offered to those with outstanding performance in relevant areas. ESG awards and certification programmes can also be set up to recognize enterprises that have made valuable contributions to sustainability and social responsibility. Furthermore, governments should strive to drive the development and promotion of green financial products, such as green bonds and sustainable development funds, to lend financing support to ESG top performers.

Second, to overcome scepticism about information and transparency, it is pivotal for governments to step up efforts in terms of disclosure and regulation. The authorities concerned can cooperate with international organizations and industry experts to establish unified ESG assessment standards so that inconsistencies in ratings can be minimized. In addition, governments should encourage enterprises, particularly unlisted companies, to disclose more ESG-related data to raise the transparency and reliability of information. To ensure the truthfulness and accuracy of information, regulators can require corporate ESG reports to be audited by independent third-party providers.

All in all, paying attention and providing feedback to opposing stakeholders are equally indispensable. It is suggested that governments should organize public forums and sharing sessions to solicit views and proposals regarding ESG standards from all sectors concerned in order to reach a consensus. Policy-making departments should also conduct extensive studies to identify concrete reasons for opposition and doubts, and to make improvements and adjustments accordingly.

Dr Yifei Zhang

Senior Lecturer

BEcon/BEcon & Fin Deputy Programme Director and Admissions Tutor