I’m against ESG, let me be clear. I don't believe that environmental, social, and governance issues can be used as a unified investment strategy. Let me explain.
The arbiters of ESG standards not only have the power to decide what is ‘good’ or ‘bad’ for the planet or whatever, but they also have the power to significantly influence financial markets and the fortunes of certain industries based on these definitions.
Those in power have always used methods to stay in power and control the narrative. ESG is simply a new way to centralize investing, justify abandoning the market, and further marginalize the community of small investors and the customer.
Preregistration and its Importance in Transparency
Prior to 2008, every collateralized obligation needed a rating. The problem was that the agencies that provided these ratings would skew them to favor issuer preference. This manipulation of ratings was motivated by the lure of short-term profits for the agency. This practice was known as rate shopping.
I am suggesting that ESG ratings could potentially be manipulated in the same manner as ratings shopping, despite ESG's goal of providing a more comprehensive, transparent framework for evaluating companies.
Rating shopping before 2008 was a serious problem that contributed to the financial crisis, but the practice was not easy to detect.
While credit ratings before the crisis were directly linked to financial returns (and hence prone to manipulation for financial gain), ESG ratings, in principle, are not directly linked to financial returns but to broader, commonly accepted "social values."
So where's the scam? If ESG is not linked to financial returns, it must be altruistic. And that's a good thing, right? Well, the scam is not in the financial returns. It's in the group-think of everyone investing in ESG, creating a self-fulfilling prophesy. That's how financial bubbles form.
If a scientist wants to improve transparency and credibility, they sometimes publish their hypothesis independent of the data they collect. This removes the tendency to skip publishing data that undermines their hypothesis.
This practice is known as preregistration, and it involves specifying a research plan in advance of a study and submitting it to a registry.
Similarly, if an individual applies for a loan, each credit check is recorded as a hit. The analogy between preregistration and credit check is that both processes involve creating a record of intent before doing something that may affect the outcome. For example, preregistering your study may prevent you from changing your hypotheses or analyses based on the data, and checking your credit score may prevent you from applying for too many loans that may lower your score.
There was no such system for corporate bond rating.
That's one reason ESG was defined. The point was to get away from strictly using financial viability for bond ratings and instead create a framework that was more comprehensive.
But one might ask, more comprehensive according to who?
A proponent of ESG might say that ESG is a broad term that encompasses many different aspects of a company's performance and impact on society and the environment.
They might point out that there is no one universally agreed-upon definition or standard for measuring ESG, and different investors, rating agencies, and stakeholders may have different preferences and priorities when it comes to ESG criteria.
And that would be true. It's also irrelevant. As long as the biggest investors communicate their flavor of ESG and as long as these big investors have liquidity, they can apply their ESG as a de facto standard.
With or without ESG the individual perspectives of large investors can sway the market, often alienating smaller investors, and the customer.
With ESG, even as unorganized and ambiguous as it is, at least we know who these companies are pandering to (hint, it's not the small investors or the customer).
Once this is realized and the pandering corporations find that they only have big investors and no customers, the bubble will burst. The next step after that, there will be an effort to democratize the understanding and interpretation of ESG standards. Right now, it's almost like a secret language, understood only by the investment elites. To fix that, there needs to be a push towards correcting the out-dated and “small-minded” beliefs of the small investors and the customer.
There needs to be a Message.
The Role of NGOs in Proliferating Propaganda
The message should be clear: ESG is not just an ideal, but it's also a standard, a framework, that underscores the importance of environmental, social and governance issues in gauging a company’s performance and future potential.
Sound familiar? It's the message of every television show, news segment, and movie from the Woke since 2012. Keep in mind that the AP says Obama did not do that, so maybe he did.
Actually, what happened was, the Smith-Mundt Act authorized the US Government to propagandize people outside the US. Obama made a change that allowed organizations to freely request the propaganda. This means the propaganda was no longer a state secret.
So while it is incorrect to say that the US Government was free to "push" propaganda domestically, the domestic organizations were now authorized to "pull" that propaganda.
This means that an NGO could get the propaganda being actively spread to the world. They could be on the same page.
What's an NGO? It's a Non-government organization. It's anything. It can be a charity or a SuperPAC. Often, it's a megaphone for a corporate entity, governmental organization, or a mega-billionaire. If they so choose, they can be used to proliferate any propaganda, not just the kind disseminated by government.
So, in a sense, the mechanisms were in place for the big investors, the ESG standards setters, and the entities responsible for shaping public opinion to align their message with that being globally broadcasted.
And this brings me back to my feelings about ESG.
The danger with ESG, as I see it, comes from its myopic focus on righting every wrong, regardless of the business sense, or lack thereof.
Not only that, but much like credit ratings pre-2008, big investors' interpretation of the ESG criteria used to rate companies could, in theory, be influenced by their own preference, thereby skewing the market to favor their investments, while veiling this manipulation under the guise of moral righteousness.
In other words, when the bond market turned toxic after the 2008 crisis, hedge funds and other big players needed a new place to park their money. They turned to the cultivation of ESG investing, not because they were particularly concerned about the environment, social issues, or good governance, but because they saw it as a convenient and lucrative opportunity.
Meanwhile, NGOs are left to play a bit role, trying to influence and educate small investors and the general public about ESG issues. But their impact is limited compared to the influence and resources of the big players.
Moreover, just as the definition and interpretation of ESG factors remain murky and completely subjective, there is considerable ambiguity about how ESG factors are measured and how they relate to financial performance, if at all.
The Flaws of ESG: A Reflection on Regulatory Capture
As result, there's no merit to the ESG concept. It requires blind faith in the system, even broken as it is. At best, the ESG landscape has the potential to be rigged and manipulated by powerful players. At worst, it might lead us to a market environment where the practicality of business operations and genuine profitability are overshadowed by socially constructed, subjective "message."
It’s not that I think that companies should be irresponsible or that investors should ignore the potential risks of capitalism run amok. The problem is that ESG is offered as a solution to the problem of 'too-big-to-fail.' That didn't happen because of capitalism run amok. It happened because of regulatory capture.
Just as with the subprime mortgage crisis where complicated financial products were peddled as secure investments in the name of market diversification, ESG is susceptible to manipulation and interpretation according to the whims and wants of 'too-big-to-fail' investors and entities.
ESG is yet another, more complicated form of regulatory capture.