Welcome to Zero. I am Akshatrati.
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're looking at the history of ESG
and its future. Reporter Sagel 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 Francis Schotzkoff 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 are 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 too, after the Great Crash in the US.
All the way back in nineteen ten twenty nine.
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 nineteen twenty nine. After that happened in the US, in particular, financial reporting began to be standardized. It took, as we know, decades, and the ifrs and the GAP rules in the US are still changing to accommodate the changing economy.
These gap rules there sort of got this weird acronym generally acceptable accounting practices. Is that right?
Yeah? Man, 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 match is that they're doing well here and not well there 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?
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 a company 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 twenty twelve twenty thirteen.
So about a decade ago is when you really started doing rule making 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 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're 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 rule making, starting in twenty nineteen. Why was it called the Golden age?
That's right. In twenty nineteen, you begin with the creation of what's called the Taxonomy Regulation. The idea there on the EUS 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 list of activities that would also be socially sustainable. And the idea there was to help companies that to help investors to identify our right, is this business sustainable
or not? Can we anticipate this would exist and help the world help people implant it. In twenty thirty forty 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, whereas with ESG rules it's only really been ten 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 has 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 rule making peered 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 Finest Disclosure Regulation, for example, that was implemented in March of twenty twenty one, 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 being 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, come with new acronyms csrdcst PD. 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 is 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 fifty thousand when it first was conceived to report on all these various ESG factors.
And then after that comes CS triple D, which is supposed to create punishments if the companies get it wrong. Is that right and what is CS trip D?
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 CS triple D 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 CS triple D is that that is the stick that prompts companies to actually take action. It includes a civiliability 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 Director was the twenty thirteen collapse of the Rana Plaza in Bangladesh, when hundreds of women died, hundreds of women who were so enclosed 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 Director because it's a way of saying, look, you company have an imp 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 the larger companies need to be prayered for climate change. There are deniers out there, of course, we know that, but the vast majority of the large global companies acknowledge that the climate change exists and something needs to be done about it, and investors and other stakeholders want to know what these companies are doing.
So now we've got a little bit of an understanding of how the rulemaking began, where there's been pushed back 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, 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 US, 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 pairing 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 pair 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 and the EU is what the US wants to do. You've done reporting that the Commerce Secretary, Howard Lutnik 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 side is that the EU rules are engaging in what's called extra territoriality. 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 some, as we know, the vast majority of those are going to be made somewhere
else and imported into the BLOCK. The US 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 US 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 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 US side too, because the US does do rulemaking that has extra territorial impact all the time. Sanctions are a very good case in point. Right, they can go after Russia or Iran and leay sanctions on them and stop their companies from doing whatever the US wants. So how is it that the US can then turn around and tell the EU, well, your rules are having an extra territorial 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 extra territorial reach. It's hard to say how that that battle over extra territoriality will.
End after the break. New York based reporters see Kushion 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. Sagel, 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 twentieth century applying the same lens to non financial disclosures. In the twenty first 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 routes 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 apartheids. So this pushed a bunch of investors mainly actually in the Boston area to use their shoholder clout to push companies to start doing good.
And that had some success, right because we know that apartheid era 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.
Two thousand and four, two thousand and five officials at the UN and they coined this label ESG. They wanted to actually pivot away from do gooding investing in moral investing, and they want to basically use the language of Wall Street, which is risks and opportunities. Socially responsible investing actually kind of was criticized 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 they're 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. You know, Europe is trying to make some progress, but in the US, where there's no rule making 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 our where you have clear goals set on emissions, on reaching climate targets, could you just talk us through what the backlash in the US has been, which began well before trump second term began.
Yeah, that's right. You could trace its early routes to twenty twenty one, 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 yeah, it was pretty low key, under the radar.
But towards the end of twenty twenty one, Ronda Santis, then Florida governor who was eyeing a run for president, he took on this attack on ESG and started attacking Black Rock, whose CEO I think has been a big champion of ESG. Then twenty twenty two, Elon Musk, Peter Thiel, and even former Vice President Mike Prince all piled in and started characterizing ESG as well capitalism and 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.
ES and G.
Lately we've seen ESU risks and that's coming in the form of insurance. We've seen big insurance companies leave states like California, Yorkshire obviously prone to to extreme weather events like wildfires, so that's been been a big risk on the s. We've seen, perhatually more concrete examples of risk 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 party 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 like sort of like Forward and General Motors, and they had to put millions of dollars aside. Their share price is tanked and just to explain, like the worker strikes at the s in issue, it's about worker rights, labor 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 I mean 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 twenty twenty, we've seen a lot of companies ramp up
their board diversity initiatives which recently haven't actually been unwound. Yeah, it's mainly S and E, which is where you see the sort of 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 our ESG minded investors who understand these risks, who are sitting in the US welcoming of the Use approach which is actually doing the rulemaking, even if it is not the US that is taking the lead.
I mean, it is 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 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, 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 Blue state clients, pension plans in California and New York, they have European clients that this still in the case of two and still 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. Quietly it's a good word. It's e flom called green hushing, where people are still doing the work but just not being so vocal about it.
Now, thank you, Sigel, 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 twelve hundred 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 zero
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