Nothing concentrates the collective mind of the markets more than an Elon Musk tweet, and his furious reaction to Tesla’s removal from the S&P500 environmental, social and governance index has given fresh energy to the debate over sustainable finance measurements.
“ESG is a scam. It has been weaponized by phony social justice warriors,” Musk tweeted on May 18, adding that S&P had lost its integrity.
His intervention came soon after BlackRock announced that it will support fewer shareholder resolutions linked to climate change this year because proposals are becoming too prescriptive.
These shifts in tack by the head of the biggest electric vehicle maker and the world’s largest asset manager looked like a victory for the self-described “anti-woke” campaigners who are trying to generate a backlash against the application of ESG principles in finance.
Strive Asset Management, a new anti-woke fund that launched in May, drew attention that might seem disproportionate to its $20 million of seed financing because it has backing from well-known investors such as PayPal co-founder Peter Thiel, hedge fund manager Bill Ackman and Cantor Fitzgerald head Howard Lutnick.
Strive was set up by Vivek Ramaswamy, a former hedge fund manager who is the author of a book called 'Woke Inc' that puts the case against stakeholder capitalism. The new fund aims to put into practice his attempt to combat that stakeholder capitalism with what he calls "excellence capitalism".
Strive tried to position itself as a plucky outsider by saying that it aims to solve a fiduciary problem created by the big three US asset managers – BlackRock, State Street and Vanguard – with their collective assets of over $20 trillion.
Tough spot
Excellence capitalism may or may not catch on as a phrase, but there is no question that the biggest asset managers are caught in a tough spot at the moment over endorsement of ESG principles.
ESG funds have been performing poorly this year, in large part because they normally have disproportionate exposure to technology stocks, which are in a slump that is even affecting firms with a virtually unassailable share of their markets such as Alphabet, Apple and Meta.
Regulatory challenges are also mounting. On May 23, the Securities and Exchange Commission (SEC) fined BNY Mellon’s investment division $1.5 million for misstatements and omissions about ESG considerations used in some of its mutual funds.
Such a nominal fine can be seen as an attempt by the SEC to remind asset managers that the regulator intends to police their claims about the application of ESG principles. It also serves as a curtain raiser for the SEC’s planned new rules on ESG disclosure by funds.
Any further fines levied are likely to prompt opportunistic legal cases against asset managers over alleged infractions related to ESG commitments.
The current focus on sustainable investing might imply that the chief risk to banks over a backlash against ESG will come through their own asset management divisions.
Deutsche Bank’s asset management arm DWS is also under investigation for ESG misrepresentation, for example. Other banks are no doubt double-checking the claims made by their own investment managers.
A controversial speech made by HSBC Asset Management’s head of responsible investing Stuart Kirk that likened climate change activists to “nut jobs” was also a reminder that reputational risk can come from unexpected quarters.
A revival in demand for fossil fuel financing will place banks in a quandary that could be more challenging than conducting an audit of ESG fund marketing brochures and double-checking presentations by managers
But a revival in demand for fossil fuel financing will place banks in a different quandary that could be more challenging than conducting an audit of ESG fund marketing brochures and double-checking presentations by managers.
The surge in price for fossil fuels that has been intensified by Russia’s invasion of Ukraine is likely to create financing opportunities that promise attractive revenue opportunities for banks.
Saudi Arabia’s Aramco has overtaken Apple as the world’s most valuable company and may take advantage of the current boom in energy dealing to conduct an IPO of its trading arm.
Goldman Sachs, JPMorgan and Morgan Stanley are reportedly in discussions about a listing for Aramco Trading in what will no doubt be a lucrative fee earning mandate, if a deal goes ahead.
Any deal will inevitably bring further charges of hypocrisy against the banks involved, for simultaneously promoting ESG products and working for an oil producer.
JPMorgan is in a particularly difficult position because its leading market share leaves it with an unwelcome title as the biggest provider of fossil-fuel financing.
At JPMorgan’s investor day in New York on May 23, president and investment bank head Daniel Pinto highlighted that ESG is one of four “strategic pillars” in corporate finance where the firm wants to capture new growth opportunities and increase market share. The other three pillars for investment-banking fee growth were middle-market clients, private capital and Asia-Pacific customers.
Pinto also noted that JPMorgan was the leading bank by fee generation from energy clients between 2017 and 2021, and that this sector accounted for 10% of the overall investment banking revenue pool in that period, however.
Impairment losses
Energy clients are likely to account for a greater share of the fee wallet across equity and debt capital markets and M&A this year, and most likely for 2023 as well.
That means that if JPMorgan wants to retain its overall global leadership in revenue from investment banking it will effectively be forced to keep energy deals coming.
Some financing can be positioned as assisting energy companies in their transition to a more sustainable global economy. But much of it will be straightforward funding of attempts by fossil-fuel companies to meet higher demand.
A Bank of England report on the financial risks posed by climate change that was released on May 24 included a section highlighting that banks face potentially high impairment losses in sectors led by oil and gas extraction.
The report said that under likely scenarios there could be cumulative impairment losses averaging 35% for lending to sectors such as energy production, though the regulator noted that some of its extrapolations were based on the assumption that banks and insurers would take limited steps to adjust exposure and acknowledged that climate-risk management and evaluation efforts are underway at most firms.
But while there is certainly a long-term risk to banks in all regions from exposure to energy clients, there is also a shorter-term reputational risk from the current opportunity to provide financing and advisory services to a booming sector.
The road to reducing fossil-fuel financing by big banks will feel much tougher to senior bankers if they are forced to change deeply ingrained habits and pass up the opportunity to compete for lucrative mandates from energy companies.
