Why (almost) everyone hates ESG right now
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Welcome to Xero. I am Akshat Rati. This week, the ESG backlash. The world of ESG regulation and investing was already suffering a period of shaky confidence even before Donald Trump came back to the White House. And now…

Trump appears to be bringing in a new period of uncertainty about just how accountable companies will have to be to governments and investors when it comes to their environmental, social and governance policies. So this week, we are looking at the history of ESG and its future. Reporter Sejal Kishan, who has been watching these developments from New York, tells me how the US used to be a leader in ESG once upon a time

And we talk about why many companies today are still keeping their ESG plans in place, but just not talking about it. But first, I spoke with Copenhagen-based reporter Frances Schwarzkopf about how the ESG movement grew into its current form, why Europe is leading on it, and why major rollbacks appear imminent. Fran, welcome to the show. Thanks very much for inviting me.

So ESG is at an inflection point, both in Europe, where you're based, and around the world, most notably in the US. Can you take us a little bit back in time and tell us about the origins of ESG? Before we get to ESG, let's go further back in time to after the Great Depression.

crash in the US. All the way back in 1929. Yep, that's right. All the way back then, there was very little regulation around how companies needed to report their earnings. That was triggered, as we know now from historians' accounts of financial incongruities in many ways. And at the time, there were very few regulations around how companies had to report information. And as a consequence, there was a lot of

Yeah, shaky reporting. And that helped fuel the Great Depression and the crash of 1929. After that happened, in the U.S. in particular, financial reporting began to be standardized. It took, as we know, decades. And the IFRS and the GAAP rules in the U.S. are still changing to accommodate the changing economy.

These gap rules, they're sort of got this weird acronym, generally acceptable accounting practices. Is that right? Yeah. And it's a fabulously banal description of exactly what it is. They lay out how companies are supposed to talk about their finances in terms that are standardized so that an investor can look across different companies and say, oh, you know, this matches that. They're doing well here and not well there. Right.

without having to worry that a company is somehow fudging the figures. And so these environmental social governance factors, as we know them as ESG today, they are known as non-financial metrics, which is not just about how much money did you make in profits, how much revenue did you raise as a company, but going beyond that. So when did that come into the picture? Of course.

Corporate sustainability or corporate social responsibility has been around for several decades. It grew out of many different kinds of bad news events, companies being caught in various polluting or mistreating their workers. And the perspective over time has changed. So it's the company is not just beholden to its shareholders, but also to society.

That solidified in the EU around a piece of legislation called the Non-Financial Reporting Directive. And that emerged actually after the financial crisis.

around 2012, 2013. So about a decade ago is when you really started doing rulemaking around these non-financial metrics. Before that, it was just companies using those metrics as a voluntary disclosure to investors that, look, we care about the environment. Here's what we're doing about it. We care about society as we are doing about gender diversity in our workforce or something.

Yeah, at first companies reported on their own. And then the EU in the last decade after the financial crisis saw the need for companies to be mandated more or less to report on these kinds of factors. And they created what's called the non-financial reporting directive. But even that failed to work.

provide investors and the wider world with the kind of information people felt would tell them about what companies were doing. The information was not standardized, for example. For example, on human rights, a company might say, well, we adhere to UN policies around human rights, and that would conceivably be the end of it. And

without explaining what they actually do, explaining where the risks are, explaining what efforts they make to actually identify possible human rights violations in their supply chains and in their operations. And so the EU starts making rules. They are still a bit vague. They're not quite helping investors to use non-financial metrics to make decisions. But then comes what

non-governmental organizations called the Golden Age of ESG rulemaking starting in 2019. Why was it called the Golden Age? That's right. In 2019, you begin with the creation of what's called the taxonomy regulation. The idea there on the EU's part was to create a list of business activities, business operations that are considered to be

In the beginning, environmentally sustainable. Eventually, they had hoped to create a taxonomy or a list of activities that would also be socially sustainable. And the idea there was to help companies and to help investors to identify, all right, is this business sustainable or not? Can we anticipate this would exist and help the world, help people and planet in 20, 30, 40 years?

After that, they started creating a whole bunch of disclosure requirements around that and around the finance industry. The next step was called the Sustainable Finance Disclosure Regulation, which mandated that banks and insurers and other organizations report on some of these factors. You know, in one way, even to get to the very metrics that we take for granted now, which is profits and revenues, it took decades to

Whereas with ESG rules, it's only really been 10 years in the making. Why is it so complicated to get those rules to be good enough for investors to actually make decisions or good enough for companies to feel they are not spending far too much time reporting on them? The first reason both

that companies give and banks and asset managers give is data. Data, data, data. These are things that people haven't measured. They've never thought really about how much water they use beyond paying their water bill.

They've never thought about how much carbon is encapsulated in the buildings they occupy. Although gender's been around for a longer period of time, they've not dug deep into that. And then you also have more controversial issues like labor union participation. The second thing after data is just the cost involved in getting all that together and the methodology and definitions. These are all things that are completely new. So currently, with all this rulemaking period in the golden era,

What is actually being enforced in the EU and how are companies responding to it? So far, there's been more saber rattling than financial penalties. One of the reasons is most of these pieces of regulation are being phased in over time.

The sustainable finance disclosure regulation, for example, that was implemented in March of 2021. And the first two, three years were in many asset managers and bankers' minds pretty chaotic. That piece of legislation is still going, is now under review.

And one of the expectations on the part of the regulators is that you comply as best you can. But they recognize that with these rules in flux, it's a little problematic to bean people on the head for a rule that's changing or that's not completely understood. Beyond SFDR, there are other rules that have been created, right? They come with new acronyms, CSRD, CSDD. What are those and when do they come into force? That's right.

The first set that I just referred to, the sustainable finance package, that was targeted at the finance industry. The idea was to leverage the finance industry to push the rest of the economy to begin the disclosure process. Next in line, then you have what's called the Corporate Sustainability Reporting Directive. And get ready for the next acronym, the ESRS, the European Sustainability Reporting Standards.

These are much appreciated and much loathed set of standards on what companies, both financial and non-financial, have to report. The idea was you begin with the finance industry and you push the rest of the industry. And that's what CSRD does. It requires companies to upwards of 50,000 when it first was conceived.

to report on all these various ESG factors. And then after that comes CSDD, which is supposed to create punishments if the companies get it wrong. Is that right? And what is CSDD? That's right. And that stands for the Corporate Sustainability Due Diligence Directive.

The idea there is that CSRD and even SFDR are really largely about disclosure. It's about telling people what you're doing and what you're not doing, telling people what the problem is, telling people how they're going to fix it. But disclosure doesn't necessarily mean companies are going to change their behavior. And that's where CSDD comes in, because the argument is that you kind of need a stick. We've seen bad things happen in the past.

And the idea behind CSDD is that that is the stick that prompts companies to actually take action. It includes a civil liability risk for the companies that are in scope, and it also mandates transition plans for the largest companies. Bad things have happened in the past. In fact, one of the events that triggered the creation of the Due Diligence Directive was the 2013 collapse of the Rana Plaza in Bangladesh.

When hundreds of women died, hundreds of women who were sewing clothes for the Western world and the repercussions were felt throughout the garment industry, but hardly anybody was held responsible for that. And as a consequence,

The European lawmakers, led by a Dutch parliament member named Laura Walters, designed this piece of legislation to hold companies responsible for actions in their supply chain. The argument is you can't push responsibility away by saying it was not my fault, I didn't know. And that's why there is also transition plans within the due diligence directive, because it's a way of saying, look,

you company have an impact on the world and that climate change can cause impacts for your company and say physical asset risks. Maybe your particular asset in the ocean is now more vulnerable to sea level rise as a result of climate change. And thus you need to have a plan

And so that is also the reason why the transition plans are part of the due diligence directive, because they ask companies to both look at what they are doing to tackle climate change, but also what are they doing to manage the risks that will come from climate change? Because if they are managing the risks, then the shareholders in those companies are more assured that this company has a longer future, right?

That's correct. Yeah. The argument is that larger companies need to be prepared for climate change. There are deniers out there, of course, we know that. But the vast majority of the large global companies acknowledge that climate change exists and something needs to be done about it.

And investors and other stakeholders want to know what these companies are doing. Okay, so now we've got a little bit of an understanding of how the rulemaking began, where there's been pushback and back and forth with industry, which has to happen in any sort of rulemaking. But there has been pushback and this pushback is starting to build up into this omnibus legislation. So by the time listeners hear this episode, they're going to be able to understand what's going on.

The EU might have already put out the legislation and told the world what within those ESG rules it is going to either step back on or make it easier for companies, right? What does it entail? There's been building over the last couple of years significant pushback against some of the regulations.

The concern here is largely that the demands are too great, particularly for medium-sized and smaller companies. They simply don't have the capacity at this moment in time, the resources, the knowledge to deliver the kind of information that's being required of them. Unlike in the U.S., there is general agreement that this kind of information is needed. So it's not a question of saying, let's pull the plug on all of it.

It's more a question of paring it down to the essentials. What are those essentials? Europe has one idea about how these rules need to be changed. There are indications that they are going to probably significantly pare back some of the reporting requirements. We do know that they do want to ease the burden on companies to provide all the data that these standards now require. And there are more standards coming.

And so another wrench that's been thrown in the ESG machine in the EU is what the US wants to do. You've done reporting that the Commerce Secretary Howard Lutnick is interested in using US trade tools to try and influence ESG rulemaking that is domestic to the European Union. How exactly would that work?

Yeah, one of the concerns on the U.S. side is that the EU rules are engaging in what's called extraterritoriality.

That means they're governing the behavior of businesses that are not headquartered in the EU as they have operations outside of the EU. Now, the intention of the EU was to control the production of goods and services that end up in the EU. But as we know, the vast majority of those are going to be made somewhere else and imported into the bloc.

The U.S. feels that this is an overreach, a regulatory overreach on the EU's part. It also brings up the question of competitiveness and a level playing field. The U.S. is concerned that its companies will be at a competitive disadvantage. This is somewhat ironic because one of the reasons that the EU has for rolling back some of its own ESG disclosures is because it's concerned that

that the regulations will in fact hurt its companies in the global market.

if the regulatory playing field isn't level. But isn't it hypocritical on the U.S. side too? Because the U.S. does do rulemaking that has extraterritorial impact all the time. Sanctions are a very good case in point, right? They can go after Russia or Iran and lay sanctions on them and stop their companies from doing whatever the U.S. wants. So how is it that the U.S.,

can then turn around and tell the EU, well, your rules are having an extraterritorial impact. And so please shut them. Yeah, that's exactly right. That's one of the arguments here in the EU is that the that the US does, in fact, have several pieces of legislation, money, anti money laundering, for example, among them that have extraterritorial reach. It's hard to say how that that battle over extraterritoriality will end.

After the break, New York-based reporter Sejal Kishan tells me about ESG's American history and why, with Trump back in office, companies are keeping quiet about their environmental and sustainability commitments. By the way, if you've been enjoying this episode, please take a moment to rate and review the show on Apple Podcasts and Spotify. It helps other listeners find the show.

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Sejal, welcome to the show. Good to be here. So I just spoke with Fran about the history of ESG in Europe, and we talked about how governments saw standardizing initially financial disclosures, and then in the later half of the 20th century, applying the same lens to non-financial disclosures.

In the 21st century, we've seen that Europe has become a leader in rulemaking on ESG. But within this broad idea of investing with purpose, the US has a longer history, right? Could you talk us through it?

That's right. Actually, sort of investing with a purpose traces its roots back to religious investors who were shunning things like alcohol and gambling from their investments. That then later morphed into sort of this more corporate activism. It was at the time of anti-Vietnam protests, the divestment movement in South Africa, which was under apartheid.

So this pushed a bunch of investors, mainly actually in the Boston area, to use their shareholder clout to push companies to start doing good. And that had some success, right? Because we know that apartheid era is...

investors did have an impact on the government there. And so how did it build up into what we now call ESG today? So we saw in 2004, 2005, officials at the UN, and they coined this label ESG. They want to actually pivot away from sort of do-gooding investing and moral investing. And they want to basically use the language of Wall Street, which is risks and opportunities. And

Socially responsible investing actually was criticised by mainstream finance for being too sort of granola and crunchy, so to speak. So talking about risks and opportunities was squarely in the language of bankers and traders and other investors.

So, yeah, the whole idea was for investors and finances to when they're doing their making decisions on whether to lend or finance or invest, they would also take into account environmental and social issues into that decision making. And so now within this big, broad tent of ESG factors, which are even today ill-defined in the aggregate,

Europe is trying to make some progress, but in the US, where there's no rulemaking really happening, it's whatever you kind of want to make of it. So if you just take the E part, which is probably more clearly defined than others, where you have clear goals set on emissions, on reaching climate targets,

Could you just talk us through what the backlash in the U.S. has been, which began well before Trump's second term began? Yeah, that's right. You could trace its early roots to 2021. And it was around the time when Texas passed through a state bill basically restricting business with companies that it claimed to be shunning fossil fuels.

It passed and it was pretty low-key under the radar. But towards the end of 2021, Ron DeSantis, then Florida governor, who was eyeing a run for president, he took on these attacks on ESG and started attacking BlackRock, whose CEO, I think, has been a big champion of ESG. Then 2022, Elon Musk died.

Peter Thiel, and even former Vice President Mike Pence all piled in and started characterizing ESG as woke capitalism, as something created by the radical left that would be a threat to the American way of doing business.

So if we were to take a Wall Street perspective, is there any way to know whether ESG factors, if they're looked at from the lens of risk and opportunity, if those factors have had any impact on company profits? And let's take it one by one, E, S and G.

Lately, we've seen ESU risks that's coming in the form of insurance. We've seen big insurance companies leave states like California, which are obviously prone to extreme weather events like wildfires. So that's been a big risk.

On the S, we've seen perhaps more concrete examples of risks playing out in portfolios. We've seen companies like Fox having to dole out millions of dollars in sexual harassment claims or settlements. Tesla had to pay a large penalty to a former contractor who accused the company of racism. And just two years ago, we saw the auto workers' strikes.

that really impacted the likes of Ford and General Motors. And they had to put millions of dollars aside. Their share prices tanked. And just to explain, the workers' rights, that's the S in the issue. It's about worker rights, labour issues and things like that.

And the G, which is sort of the forgotten factor in ESG, where does that play a role? Yeah, I mean, G, it's kind of mainstream finance. It's more of a process. It's not an investable idea like investing in E issues like investing in a solar company, for instance. But for the G issues, you know, boardroom diversity comes into that.

And, you know, after the George Floyd protests here in the US in 2020, we've seen a lot of companies, you know, ramp up their board diversity initiatives, which are

recently have actually been unwound. But yeah, it's mainly S&E, which is where you see the impacts on the bottom line. But if we take the Wall Street lens on ESG, which is these do provide certain risks and they provide a signal to investors looking at the portfolio that they have in their company, they seem to say there are some fundamental risks that we do need to account for as we invest.

And so are ESG-minded investors who understand these risks, who are sitting in the US, welcoming of the EU's approach, which is actually doing the rulemaking, even if it is not the US that is taking the lead? I mean, it's really a mixed bag. I mean, obviously, you'll see sustainable investors who welcome this.

and want to bring these rules on board. And to an extent, they're doing a lot of this sort of like voluntarily anyway. But we've got the likes of big groups, lobbyist groups, who are pushing back on these rules and saying that it's going to be costly. They weigh on small businesses, especially at a time where small businesses after the pandemic have struggled.

And now that we have a president who's for deregulation, there's even more stronger pushback. It's only been a month since Trump has been in power. You know, there are four more years of this. How do you expect

this to play out for ESG over the next four years? I mean, look, the pressure is going to continue. I mean, we've seen even before Trump was elected, Wall Street pretty much go silent on climate change, talking about climate risks, leaving net zero groups and really shy away. They faced investigations,

Some companies have been sued or faced legal action. And so a lot of companies are just like, hey, this has just been too much for us, more than what we bargained for. But having said that, they're not going completely silent because they still have problems.

blue state clients pension flat plans in california and new york they have european clients that they still want to cater to and still are very sort of cognizant of climate change and impacts on portfolios and especially on the e-factors i mean we are going to see more extreme weather events and those are risks that companies will face are they just quietly trying to deal with those risks now

That's right. And quietly is a good word. It's a phenomenon called green hushing, where people are still doing the work, but just not being so vocal about it now. Thank you, Sejal. Thank you. Thank you for listening to Zero. And now for the sound of the week. That's not the sound of a machine, but the sound of the wings of a hummingbird. When it's flying, a hummingbird's heart can beat as fast as 1200 times a minute.

If you like this episode, please take a moment to rate or review the show on Apple Podcasts and Spotify. Share this episode with a friend or with a bird watcher. You can get in touch at zeropod at bloomberg.net. Zero's producer is Maithili Rao. Bloomberg's head of podcast is Sage Vaughan. And head of talk is Brendan Newnham. Our theme music is composed by Wonder Lee. Special thanks to Aaron Rutkoff and Jessica Petty. I am Akshat Rati. Back soon. ♪