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Can coal investing be environmentally friendly? A contrarian take on ESG

Laurence Darmiento, Los Angeles Times on

Published in Home and Consumer News

One of the biggest investment trends over the last several years has been symbolized by a ubiquitous acronym: ESG, or environmental, social and governance.

The theory behind ESG comes in two parts: first, that investors have a responsibility to use their money to push companies to be more ethical and accountable for their actions; second, that companies with good governance and responsible practices can provide better returns over time despite potentially higher costs — as they are better adapted for a changing world where consumers, regulators and markets stand ready to punish bad actors.

ESG has proved both increasingly popular — with net inflows of $70 billion last year, a 35% increase over a record set in 2020, according to Morningstar — and correspondingly controversial. Elon Musk called it "the devil incarnate." Peter Thiel called it a "hate factory."

Advocates of ESG investing, meanwhile, have been feeling burned, raising cries of greenwashing around supposedly environmentally friendly funds that have holdings in such industries as coal or arms manufacturing.

As head of global sustainable finance for Fitch Ratings, Andrew Steel is a key arbitrator of this debate, with views likely to rankle both ESG true believers and haters. Fitch both assesses the financial risk of debt based on ESG-related factors and rates investments on their ESG impact. At the Milken Institute Global Conference this week, Steel explained why energy companies with oil, gas and coal assets can get top scores for ESG credit risk — and why strict ESG investors may be missing out on not just returns but a chance to influence the world for the better.

Steel expanded on his views in an interview that has been edited for length and clarity.

 

Q: Let's start with a fact that gets at the debate around what ESG is and isn't: A fund that includes debt issued by coal, oil and gas companies, leading emitters of carbon, can receive a top ESG credit-risk rating. Can you explain this?

A: There are a large number of mining companies, oil and gas companies that know what the environmental regulations are, they're pretty good at managing them and they manage them in a way so there's not a short-term or medium-term impact on their financial profile. So what that tells you is your mining company, in its financial forecast for the next three to five years, doesn't appear to be suffering any kind of environmental impact.

Q: Shouldn't it be about the impact of the coal mine on the environment?

A: That is only the financial materiality perspective. On a sort of morally agnostic basis, it's either material or it isn't material. I'm not making a value judgment on that. But then if I'm worried about the longer term, how do I look at that? We said the biggest risk there is the regulatory change. If you've got a net-zero [carbon emissions] target as a country, what does that mean? How do you have to change the industries in your country to achieve your net-zero target? Or how do you have to change the composition of business within your country to do that?

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