‘ESD’: an investor framework for an period of upheaval  | USAEMALL.com

Welcome back. The acronym ESG has become a red rag for many on the US right. It’s strikingly unloved even by many who have made sustainability issues their life’s work. Is it time for a rethink?

A new paper makes a strong case for an overhaul of investors’ approach to environmental, social and other long-term risks — whatever the acronym they use.

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Is ‘ESD’ the new ESG?

Germany’s biggest asset manager can now try to draw a line under what was perhaps the world’s most explosive greenwashing scandal.

DWS, a publicly listed subsidiary of Deutsche Bank, was hit in 2021 by damaging allegations from Desiree Fixler, its former sustainability head. She claimed that the company had seriously exaggerated the extent to which its fund managers took account of environmental, social and governance factors, under its heavily promoted “ESG Integration” framework. The claims led to criminal investigations in the US and Germany.

Last week, German prosecutors announced they would not press charges against former DWS chief executive Asoka Wöhrmann. The asset manager in April accepted a €25mn fine imposed by German prosecutors, having previously agreed a $19mn settlement with the US Securities and Exchange Commission.

The controversy doesn’t seem to have scared DWS away from offering sustainable investment products. The €1tn asset manager remains a major player in the field, thanks largely to its strength in passive ESG funds. But this and other scandals have fuelled a damaging perception that the “ESG” paradigm is often more about clever marketing than real substance and impact. What would a more rigorous approach look like?

According to analysts at Bernstein, investors need to pay more attention to “ESD” — emerging, strategic and disruptive factors. In a recent paper for clients, they argued that investors should take a more expansive view of the issues that affect how companies are positioned for “a future that is being reshaped in real time”.

These would include environmental and social risks and impacts, as well as vulnerabilities to geopolitical upheaval and the disruption caused by artificial intelligence advances.

Top ESD issues for the automotive sector, for example, would include regulations around carbon emissions, access to critical minerals, protectionist trade policies, and worker “talent gaps” linked to the long-term shift to electric and autonomous vehicles.

Some ESG specialists may blanch at this suggestion. If companies and investors are already paying too little attention to environmental and social issues, they might object, how will it help to put even less emphasis on them?

But Yannick Ouaknine, the lead author of the paper, argues that it makes no intellectual sense to fence off environmental and social issues from other long-term risks — and that this approach has actually been undermining the impact of ESG work.

Any rigorous comprehensive approach to assessing long-term risks, he asserts, will still place heavy emphasis on areas such as climate threats and labour standards, because they are now so clearly material to companies’ prospects.

But even those investors who take these issues seriously, Bernstein reckons, have often been taking too passive an approach: relying heavily on data publicly disclosed by companies, rather than engaging with them to obtain information and influence corporate behaviour.

In short, rather than treating long-term portfolio risk management as a tick-box exercise — or as a marketing gimmick, as in the unfortunate example cited above — fund managers may need to put in much more hard graft.

Bernstein is offering the ESD acronym as a way of shaking up the conversation around sustainable investing, without any expectation that it will be embraced as a replacement for the ESG framework. But as asset managers such as DWS seek to learn from mistakes made so far in this space, amid wider economic and geopolitical turbulence, they’d do well to stay open to fresh ideas.

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