Two bombshell articles landed recently. First a Bloomberg Businessweek piece titled The ESG Mirage, on how companies are rated (or maybe not) for their performances tied to Environmental, Social and Governance (ESG) factors. The article leads with the bold pronouncement that, “MSCI, the largest ESG rating company, doesn’t even try to measure the impact of a corporation on the world. It’s all about whether the world might mess with the bottom line.” The second article from Bloomberg reports that one of the largest rating companies – Morningstar – has just removed ESG tags from over 1,200 funds that it found were not delivering on those goals.
Why ESG is Important
ESG may have had its origins in a landmark 2005 study instigated by the United Nations and developed by 18 of the largest financial institutions entitled Who Cares Who Wins and delivered at a conference that included the financial sector, consultants, governments, and their regulators, all examining the role of the key value drivers in asset management and financial research.
Out of that study, the UN sponsored the development of 17 Sustainable Development Goals – now commonly referred to as the 17 SDGs – to help categorize the environmental and social impacts of investments. SDGs are now being used all over the world (albeit still too lightly in the U.S.) to help develop scoring systems for socially responsible investors who want to more clearly incorporate their societal values into investment decisions. For instance, most investors with ESG strategies view municipal bonds as inherently positive when it comes to environmental or social benefits, but until recently there has been little in the way of meaningful data to support their decision-making. But even with meaningful data available, it is the validity of the scoring systems that will now properly link that data to ESG elements for use in financial research, asset management, and brokerage/advisor services.
Real ESG or Real BS?
Starting as a “bland” company that helped develop indexes for the markets, the CEO and Chairman of MSCI, Henry Fernandez, had a supposed “epiphany” a few years back, deciding that his company’s new mission was going to “help global investors build better portfolios for a better world.” That sounds so nice! But as the Bloomberg article points out, the way that MSCI rates companies for its ESG scores may be mostly a greenwashing effect for a better financialized economy than anything to do with saving the planet or designing a better workplace.
And as a recent article in the Guardian points out, many companies central to the financialized economy are still boldly deceptive. After signing up to the U.N.-backed Net-Zero Banking Alliance a year ago, the largest of the European banks have since provided almost $33 Billion to oil and gas companies wanting to expand production. While similar data is still to be found in the U.S., my guess is we would find the same. Though these companies seemed to have had good intentions by making that pledge, the resistance from shareholders and prospective investors led them to continue funding these climate-damaging actions. It seems clear that many making pledges and promises to appear as “friends of the earth” are still willing to fall back to a shareholder primacy-driven mindset as friends to only profit.
Data to the Rescue
Asking companies to get real about their true impact on ESG is like playing whack-a-mole at an arcade. Imagine 17 holes where the Sustainable Development Goals pop up, and where the industry-manufactured “green-labeled” mallets smash them down, again and again, while issuing PR statements about how much they care. And though the number of socially responsible investors keeps growing at ever accelerating rates today, the number of ways businesses try to obfuscate their true impacts with almost meaningless green branding has kept pace. So far.
The good news is that the data behind how business and government organizations function, and how that impacts the 17 SDGs and other ESG metrics, is beginning to be captured and analyzed for transparency purposes in much more robust ways. For example, the women-owned and led Kestrel ESG (a Cutting Edge client), now offers a powerful ESG data product with both quantitative and qualitative insights on fixed income investments. And as Sara Olson – founder of SVT Group – points out in her recent article, other Impact standards such as Social Value International, Capitals Coalition, Impact Management Project and Science-Based Targets, are also providing better tools to understand what a “company’s risk to the world” may be. And now Morningstar has thrown down its own gauntlet of sorts, using better data to understand when asset managers’ claims about doing the planet or people any good are simply misleading and wrong.
These new ways of evaluating and scoring ESG are going to make the approach used by companies like MSCI, as described in the Bloomberg article, look irrelevant soon enough, and businesses will have far fewer ways of hiding behind their thinning greenwashed veils. And it won’t be only in the municipal bond world that these improvements happen. As more data today gets uploaded to the blockchain as a way of verifying all manner of content and actions, entities like municipal governments will need to up their game when it comes to transparency of bond-financed activities and intentional alignment with climate action and sustainability plans; and soon enough, these same scoring methods using better data on distributed ledgers will be available to rate and score all manner of companies, including private ones as well.
As the global climate catastrophe continues unabated, causing more unnatural disasters, as the data showing the ever-widening income and wealth gap becomes more transparent, and as we better connect, store and validate these data-dots to show the way companies are organized and governed, public outcries will grow louder and stronger as transparency increases. Behaviors that were once lionized purely for their focus on profitability will become vilified in the future; and if we are to make progress toward a safer planet and working environment, laws will need to be rewritten to acknowledge their detrimental impacts, or even making those actions and behaviors criminal.
You Might Run, but Can You Hide?
Which brings me to the role that law firms also play in all of this. Just as businesses will find it harder to hide behind the veneer of “responsibility” while continuing to honor shareholder primacy as their raison d’etre, the same will hold true for those who support the bad actors, with law firms at the top of the list. I predict that Big Law, and those striving to become ones, will begin to have their “McKinsey Moment” soon enough.
Employees at McKinsey & Co. have spoken up via 1,100 signatures calling their employer out for representing the largest polluters, and the giant PR firm, Edelmen has also been in the news, weakly trying to justify representing Big Oil while at the same time making bold statements about how much they believe in the environmental sustainability movement. And a recent NPR article provides more evidence of the failure of the major oil companies to live up to their own pledges to transition to clean energy. Companies like MSCI, McKinsey, Edelmen, multinational banks, big oil, and too many others that continue to practice strategic hypocrisy appear to believe that PR statements, pledges and a casual support of ESG will keep them safe, while they continue to pursue their shareholder-driven pursuit of maximum profitability. And it would be very naive to believe that these actions are taken without their lawyers’ blessings; they take great care to pass everything by them to ensure they don’t get sued. Meanwhile, the temperature gauge keeps rising; and the time we have left to fix things rapidly decreases every day. Open letters from your employees may be today’s approach, but if things don’t change soon, more radical actions will surely follow.
At a minimum, law firms will need to encourage their clients to assess and disclose their material impacts of environmental and social conditions, and on a client’s ability to meet those obligations. Those material impacts will require disclosure much like financial reporting is required today. Law firms should also be supporting their client’s positive steps required to decarbonize and improve social equity, as those will show improved valuations over longer terms.. But that will only be the beginning.
Have you Hugged Your Non-ESG Client Today?
Law firms provide an enormous role for clients – far beyond the transactional work of drafting agreements or supplying legal documents. They are counselors, advisors, and sometimes therapists to the C-Levels as the sea levels continue to rise. They are an integral part of almost all major decisions made, and they will fight to the finish on a company’s behalf – all in the name of their duty of loyalty they owe to clients.
But most importantly, law firms choose who they will represent. And (spoiler alert) it typically has to do with how much money they can make by battling to win and keep those gi-normous fees they charge. However, the unique expertise lawyers develop should not provide them a pass on being rated and called out for who they represent, or who they continue to help actually avoid the difficult and expensive work to make conforming ESG changes. Today they continue these practices all the while burnishing their “ESG creds” by the one or two good companies they may represent, or by the pro bono work they hand to their associates. But any help they may provide by doing some good ESG work is largely negated when they are still helping others who avoid it.
As ESG ratings and scoring continue to improve, and as transparency becomes not only the norm but someday baked into law (perhaps ever so slowly, thanks to those crafting such laws while pocketing donations from the same crowd), firms of all stripes will have a much greater challenge justifying their continued representation of companies that are causing us to drown, or burn, or suffer in so many other ways. Today, firms might brag about the light bulbs they’ve replaced, or the one woman or person of color they’ve added to their management team, but soon enough, they will be seen for what they really do, which is aiding and abetting non-ESG behaviors.
Every law firm must do a “conflicts check” before onboarding a client. Perhaps companies who truly care about ESG should start asking for their own kind of conflicts check from law firms. “We may hire you, but we first need to see your list of clients to be sure your work doesn’t conflict with and detract from the need to save this planet.” Law firms of all sizes may want to do their own internal ESG analysis to begin removing non-ESG clients before they too begin getting called out in ways that begin to damage their business and reputation interests. And for those firms that have already begun to take these actions, we commend you.
Cutting Edge Capital is a strategic practice of Cutting Edge Counsel. We help mission-driven enterprises and investment funds structure their organizations and design their capital raise offerings to be impact and community centered. Our mission is to help build a more just, equitable and sustainable economy. Schedule a call with us to learn more.