Week 49: How will you explain it to Ruth?

In this issue: ▸ The peculiar smell of fear ▸ Equal human rights, you know? ▸ How will you explain it to Ruth? ▸ MSCI and the ESG mirage ▸ Measuring impact on bottom line, not Earth ▸ And much more...

Dear all, 

Dominance. Full control over the narrative. Monopoly over millions and millions of everyday investment decisions that shape capital flows all over the world. Divine influence. There are few words that can fully express how dangerous this is.

I’m sitting this early morning at the kitchen table reading an article. I’m reading it several times.

The days up north have become shorter. Daylight is almost gone and a feeling of being in the complete dark leaves my mind shipwrecked. Light has become a daydream, a horizon somewhere between now and who knows when.

Light as a symbolic and physical feeling. Dialogues with myself are shorter too. Each thought usually guarded by doubt, caressed by longing. Strokes of tired, wet snow, barely covering the pavements, and the stupid cold with no real purpose.

I try to find solace in a strange place, in the back of  my mind. Seeing my life in the faces of people passing by. New streams about new mutations of viruses, countries closing down, companies sending their employees home.

The peculiar smell of fear

I remember the smell of fear during the war in the Balkans. Yes, the smell of it. It has a very peculiar smell. Raw iron drenched in sweat. Salty with a deep tone of flesh. Fear. Paralysing.

Years later when I travelled to different countries I came across the same smell from time to time. In the shanty towns in Africa, villages in Bangladesh, rural parts of South America. Deserted road towns in USA, empty villages in Romania. Always that peculiar smell.

The other day while walking down the street in Copenhagen I noticed that smell again. Unexpected.

And now, back home at the kitchen table in Stockholm, reading some of the pieces I’m about to share with you, I felt it again. Fear. That smell.

The typical human reaction is to try to convince your mind that it is not in danger. Courage sets in on autopilot and you pull yourself up. You look at the world, you want your life to matter, you want to feel some kind of purpose. Courage.

We are cornering ourselves into cages of fear where everything is a risk, everything is a threat to status quo, regardless of the fact that status quo is a risk too. But one we have learned to live with, one we embrace and protect. Courage. 

Dominance, light and fear. A tricky combination to start a newsletter with, but a courageous one. There were many before us and there will be many after us that have had it and will need to have it. Courage.

Equal human rights, you know?

Human Rights Day is celebrated every year on 10 December, the day the United Nations General Assembly adopted, in 1948, the Universal Declaration of Human Rights (UDHR).

The UDHR is a milestone document, which proclaims the inalienable rights that everyone is entitled to as a human being – regardless of race, colour, religion, sex, language, political or other opinion, national or social origin, property, birth or other status. Available in more than 500 languages, it is the most translated document in the world. Yeah, it matters and it matters a lot.

Each and every day people around the world die to protect their human rights. But the world’s business community stands silent on the 10th of December. No pledges, no theatre, no fanfare. Silent. There a few pieces here and there addressing the importance of these “human rights”, and the business community is in deep agreement that they do matter and are by all means “integrated in the fabric of every company’s operations” like walls, carpets and printers in their offices.

This year’s Human Rights Day theme relates to 'Equality' and Article 1 of the UDHR: “All human beings are born free and equal in dignity and rights.” 

Emphasis here is on all human beings.

However, multinational corporations, some of the wealthiest and most powerful entities in the world (69 of the richest 100 entities in the world are corporations, not countries), have often escaped accountability when their operations have hurt workers, the surrounding communities, or the environment.

And governments aligned with powerful companies have frequently failed to regulate corporate activity, or have not enforced and even eliminated existing protections for workers, consumers, and the environment.

Millions of adults and children around the world suffer abuses as workers obtaining raw materials, toiling on farms, and making products for the global market. They are at the bottom of global supply chains, for everything from everyday goods like vegetables and seafood to luxury items like jewellery and designer clothing that end up on store shelves worldwide. 

How will you explain it to Ruth?

“Ruth,” age 13, is one of them. She is processing gold by mixing toxic mercury with her bare hands into ground-up gold ore near a mine in the Philippines. She told Human Rights Watch that she’s been working since she was 9 after dropping out of school, though she often doesn’t get paid by the man who gave her bags of gold ore to process.

So what are we ESG investors going to tell Ruth and the millions of children working to death about our ESG processes, our active engagement efforts, and our splendid SDG reporting tools?

How are we going to explain to her that our investment approach is better than the different indexes, and by all means far more ESG than the competition? How can we explain this to Ruth?

We all invest in the “sustainable transition” delivered to us by the hands of millions of children that will never drive a Tesla or let alone own an iPhone. We will tell Ruth that this is complex, and that it is a process and we are moving things around and that piece by piece we are moving things forward and that our SDG reporting for the companies we invest looks better and better every year and… Well, you get the picture.

Ruth’s Human Rights are less important for us. It’s that simple. 

I have seen it in the artisan mines around the world. The eyes of children looking up from the pits, their tiny bodies barely have enough space to turn around and look up towards the light. And the silent questions hanging in the air.

Why? I’m sure these children would understand our definitions of ESG only is they had been able to take some time off from digging for the materials needed for our “sustainable transition”. 

Every ESG labelled fund in the world has a responsibility for this. Every ESG professional, analyst, manager. Every corporate CEO. Every shareholder, partner. All of us. We know what is going on and we have known this for years and we can do something about it. Yes we can.  

MSCI and the ESG mirage

What gets measured gets done, someone once said. But in the ESG world it’s more about who is doing the measurements and what they are really trying to protect.

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.

For more than two decades, MSCI Inc. was a bland Wall Street company that made its money by arranging stocks into indexes for other companies that sell investments. Looking for ways into Asian tech? MSCI has indexes by country, sector, and market capitalization. Thinking about the implications of demographic shifts? Try the Ageing Society Opportunities Index.

MSCI’s clients turn these indexes into portfolios or financial products for investors worldwide. BlackRock Inc., the world’s biggest asset manager, with $10 trillion under management, is MSCI’s biggest customer.

Sales have historically been good, but no one was ever going to include MSCI itself in an index of sexy stocks. Then Henry Fernandez, the only chairman and chief executive officer MSCI has ever had, saw it was time for a change. In a presentation in February 2019 for the analysts who rate MSCI’s stock, he said the company’s data products, the source of its profits, were just “a means to an end.” The actual mission of the company, he said, “is to help global investors build better portfolios for a better world.”

Fernandez was borrowing the language from an idealistic movement that originated with a couple of fringe money managers in the 1980s. Yesterday’s heterodoxy is today’s Wall Street sales cliché. Investment firms have been capturing trillions of dollars from retail investors, pension funds, and others with promises that the stocks and bonds of big companies can yield tidy returns while also helping to save the planet or make life better for its people.

The sale of these investments is now the fastest-growing segment of the global financial-services industry, thanks to marketing built on dire warnings about the climate crisis, wide-scale social unrest, and the pandemic.

Measuring impact on bottom line, not Earth

No single company is more critical to Wall Street’s new profit engine than MSCI, which dominates a foundational yet unregulated piece of the business: producing ratings on corporate “environmental, social, and governance” practices. BlackRock and other investment salesmen use these ESG ratings, as they’re called, to justify a “sustainable” label on stock and bond funds. For a significant number of investors, it’s a powerful attraction.

Yet there’s virtually no connection between MSCI’s “better world” marketing and its methodology. Yeah, please pay attention now. If you are by any means interested in the ESG wonderland and know about ESG ratings, this is where you should spend a couple of minutes and read it thoroughly.

ESG ratings don’t measure a company’s impact on the Earth and society. In fact, they gauge the opposite: the potential impact of the world on the company and its shareholders. MSCI doesn’t dispute this characterization. It defends its methodology as the most financially relevant for the companies it rates.

This critical feature of the ESG system, which flips the very notion of sustainable investing on its head for many investors, can be seen repeatedly in thousands of pages of MSCI’s rating reports.

Bloomberg Businessweek analysed every ESG rating upgrade that MSCI awarded to companies in the S&P 500 from January 2020 through June of this year, as a record amount of cash flowed into ESG funds. In all, the review included 155 S&P 500 companies and their upgrades.

The most striking feature of the system is how rarely a company’s record on climate change seems to get in the way of its climb up the ESG ladder, or even to factor at all.

The curious example of McDonald’s rating upgrade

McDonald’s Corp., one of the world’s largest beef purchasers, generated more greenhouse gas emissions in 2019 than Portugal or Hungary, because of the company’s supply chain. McDonald’s produced 54 million tons of emissions that year, an increase of about 7% in four years.

Yet on April 23, MSCI gave McDonald’s a ratings upgrade, citing the company’s environmental practices. MSCI did this after dropping carbon emissions from any consideration in the calculation of McDonald’s rating. Why? Because MSCI determined that climate change neither poses a risk nor offers “opportunities” to the company’s bottom line.

MSCI then recalculated McDonald’s environmental score to give it credit for mitigating “risks associated with packaging material and waste” relative to its peers. That included McDonald’s installation of recycling bins at an unspecified number of locations in France and the U.K. countries where the company faces potential sanctions or regulations if it doesn’t recycle.

In this assessment, as in all others, MSCI was looking only at whether environmental issues had the potential to harm the company. Any mitigation of risks to the planet was incidental. 

This approach often yields a kind of doublespeak within the pages of a rating report. An upgrade based on a chemical company’s “water stress” score, for example, doesn’t involve measuring the company’s impact on the water supplies of the communities where it makes chemicals. Rather, it measures whether the communities have enough water to sustain their factories. This applies even if MSCI’s analysts find little evidence the company is trying to restrict discharges into local water systems. 

Almost half of the 155 companies that got MSCI upgrades never took the basic step of fully disclosing their greenhouse gas emissions. Only one of the 155 upgrades examined by Businessweek cited an actual cut in emissions as a key factor.

As the OECD warned in a 2020 report, this means investors who rely on “E” scores and ratings, even high-ranking ones, can unwittingly increase the carbon footprint of their pensions or other investments.

The EU taxonomy is already divisive

The EU has passed the first part of its rulebook on climate friendly investments, which from next year will define which activities can be labelled as green in sectors including transport and buildings. The first section of the EU’s sustainable finance taxonomy will apply from Jan. 1 2022, having passed a scrutiny period that ended on Wednesday night.

Roughly a dozen countries – among them France, Poland, Finland and Hungary – had objected to the rules, but did not have the majority needed to block them, EU officials said. The most politically sensitive part of the EU taxonomy is still to come.

The EU is due to decide this month whether to label gas and nuclear energy investments as green. The decision has split EU countries and been delayed by a year amid intense political lobbying. EU climate policy chief Frans Timmermans said the rules would need to reflect that gas and nuclear are needed for the EU's transition to reach net zero emissions by 2050.

Pro-nuclear countries including France cite the energy source's low CO2 emissions, while opponents warn of the environmental impact of radioactive waste.

Gas is similarly divisive, with countries split between those that say gas investments are needed to help them quit more-polluting coal, and those that warn labelling a fossil fuel as green is not credible.

Gas is not a transitional fuel

If you ask me, both gas and nuclear will be defined as “sustainable” with some kind of language annex, the small print, explaining in which cases it can be seen as sustainable. That way both France and Germany will be happy and can continue running the economic model that brought us here.

But let’s take a closer look at this and how the EU’s actions create a deep divide within Europe. Gas is widely branded as a transitional or a bridge fuel. The idea is that on the road from coal to renewables, we need to go through gas which emits, at the point of burning only, half the CO2 emissions.

But if we look at countries that significantly reduced coal in power generation, we will see that coal is not replaced by gas and doesn’t behave as a transitional fuel. Countries reduce coal, but gas consumption does not increase. Instead it stays the same or even declines.

The UK is a striking example. In 2012 coal generation peaked at 40 %. Today, coal generates less than 3 % of British electricity, and it is on the way to being fully phased out in 2024. In the last two decades, gas demand has remained flat. Furthermore, both gas and nuclear have shown signs of relative decline over the previous five years.

Germany is a unique case because of its commitment to close down nuclear by the end of 2022. In the last decade, it reduced its coal power generation by 44 % and its nuclear generation by 49 %. Amid this massive decline, gas generation has increased by only 13 % (or an absolute change of 1.9 percentage points).

With some temporary and seasonal variations, the trend is similar in Denmark, Spain, Italy, Slovenia, Hungary and other European countries. In most cases, gas demand remains flat or declines despite the availability of underutilised gas generation capacity that could be turned on with a switch of a button.

Branding gas as a transitional fuel, or the more delicate bureaucratic term “transitional activity”, is the main argument for including gas as a green fuel in the Taxonomy. This branding will impact many investment decisions, public policies, and spending.

Gas being labelled “a transitional fuel” is the primary justification for allowing countries to build gas power plants under the so-called DNSH (Do no significant harm) principle. When assessing the eligibility of gas power plants as replacement of coal capacity, the European Commission requires that the newly built gas generation capacity should “result in the simultaneous closure of a significantly more carbon-intensive power plant and/or heat generation facility (e.g. coal, lignite or oil) with at least the same capacity”.

In other words, if a country closes 1GW of coal, it will not do significant harm if it builds up 1GW of gas generation.

Applied to gas, the DNSH principle will inflict harm mainly on Central and Eastern European countries that do not have a ready-to-run gas generation capacity and will need to invest in newly built power plants to “not do so such a significant harm”.

This very expensive irony will only widen the technology gap between West and East, and in a few years, we will see how the Green Deal is much greener for the West, but not that green, and not that profitable and beneficial for the East. 

That’s all for this week. Courage is not for free. It never was and never will be. 

Best regards,
Sasja