In the fight against climate change, ‘responsible investing’ has become somewhat of a buzzword, with environmental, social, and governance (ESG) based-investing becoming an important criteria for determining the potential for investment in a company.
ESG-based investors typically decide whether to remain invested in a company by evaluating the company’s carbon emissions, environmental impact, commitment to diversity, social impact, and management practices. Recently, the practice of divesting from companies that fail to meet ESG criteria has become standard for those bearing the title of a responsible and socially-conscious investor.
While this divestment previously has typically ostracized companies in sectors such as the tobacco and arms industries, the movement to divest from fossil fuel and high carbon emitter companies has taken investors by storm. Universities have also been playing a more active role in divesting from companies. The idea is that, by divesting from companies that fail to meet ESG criteria, investors will be able to drive down these companies’ share prices.
This increases their cost of capital, which is the return that a company is required to achieve on a project to continue justifying the cost that the project takes up. The higher required return limits their options for expansion. Thus, divestment would reduce these high carbon emitting companies’ scope to expand. This reduction limits their carbon dioxide production and ultimately slows down the rate of climate change.
Last October, following Harvard University’s lead, U of T President Meric Gertler made the announcement that U of T’s investment manager, the University of Toronto Asset Management Corporation (UTAM), would immediately divest from all fossil fuel investments in their $4 billion endowment fund. U of T made the decision in an effort to “accelerate the transition to a low-carbon economy.”
At the moment, roughly 58 per cent of the combined 20 largest college and university endowment funds in the US have fully or partially divested from fossil fuel companies. Students at Canadian universities such as the University of Victoria, the University of British Columbia, and McGill University have made similar calls for divestment. Several of these universities have honoured and acted upon these demands.
However, Jonathan B. Berk of the Stanford Graduate School of Business and Jules van Binsbergen of the Wharton School wrote a paper on why this divestment strategy is rather ineffective in reaching its intended targets. Specifically, divestment has virtually no impact on a company’s cost of capital, as other investors are quick to buy the dumped shares. As a result, the assets are merely redistributed, with no net benefit attributed to the climate fight.
There would need to be an “overwhelming majority of investors” engaged in divestment for the divestment strategy to work, yet such a future seems unrealistic. For instance, at the moment, only two per cent of US stock market wealth is currently invested in ESG-based investments.
Tariq Fancy, the former chief investment officer for sustainable investing at BlackRock, a financial planning and investment management company, made similar remarks last August when he acted as a Wall Street whistleblower, exposing ESG investing and divestment strategies as akin to the “greenwashing” of the economic system. Or in other words, he claimed that ESG is nothing more than “marketing hype, PR spin and disingenuous promises [sic] from the investment community.”
Fancy addressed how investment funds claim that they take into account climate change-related risks when determining whether to invest in a company — something that the UTAM itself has boasted — even though this ultimately has no effect in fighting against climate change. Claiming that they are climate-conscious by divesting protects these investors from the problem, rather than addressing the problem itself.
In addition, contrary to Gertler’s statement, which expresses hope that ESG investment “will also encourage government actors at home and abroad to intensify their efforts to tackle the challenge of climate change,” Fancy has strongly criticized this manner of holding out hope of eventual climate change improvements, labelling it as stalling. He instead believes that people should lobby for government intervention and a carbon tax.
Alternatively, Berk and van Binsbergen suggest that to truly make a difference through the market, investors should aim to play an active role, utilizing their voting power to drive change.
Just last year, with the support of Blackrock, financial service companies Vanguard and State Street, and hedge fund Engine No. 1 succeeded in using its proxy votes to replace three ExxonMobil board directors and push climate action. This was an important moment at a company otherwise labelled in Britannica as “one of the world’s top three oil and energy concerns.”
Although recently facing divestment pressures from their professors, Western University has opted to take on the role of the active investor, citing similar arguments as Berk and van Binsbergen.
Thus, the question stands that if taking part in “greenwashing” through divestment and ESG-based investment practices is ineffective, then why are universities pushing for this practice in their efforts to tackle climate change?