What the Russian Invasion of Ukraine reveals about ESG

Commentary: The Russian invasion of Ukraine has prompted calls for defence and weapons stocks to be included in ESG funds. But given ever-present concerns over fragmentation and greenwashing, can ESG reconcile the varying imperatives of sustainability, shareholders and war under the same rubric? Or does green finance need a more focused approach to meeting net zero goals?

Russia’s invasion of Ukraine on 24 February 2022 shook the world. Beyond a military and humanitarian conflict, major global impacts have been felt in the realm of energy, supply chains and the fight against climate change.

The days following the invasion saw the boycott by major global businesses of operations in Russia, the divestment by major oil companies of assets in Russia, and a rapid and unprecedented imposition of sanctions on the Russian regime.

What does this have to do with green finance?

Most strikingly, in the quest to resist Russian aggression, calls to enlist the ESG industry have also surfaced. Long considered a taboo sector widely included in ESG exclusion lists, analysts from Citi now argue that weapons and defence companies should be included in ESG funds, as they help in “defending the values of liberal democracies and creating a deterrent, which preserves peace and global stability.”¹As Merryn Somerset Webb, a columnist at the Financial Times, forcefully puts the point across, “supplying weapons to the invaded underdog in an unprovoked fight is a social good.”²

Green Finance Before the Russian invasion of Ukraine

Leading up to the Ukraine invasion, the immediate concerns in the world of sustainable finance centred around two main areas. Firstly, the mainstreaming of climate change as a core concern of businesses, financial institutions and policymakers. This has coalesced around the rise of ESG as the go-to framework, incorporating “environmental”, “social” and “governance” criteria. In general, this has happened in parallel and only sometimes overlapping with the rise of green taxonomies, which distinguish environmentally friendly “green” assets from harmful “brown” ones.

But while the dominant framings of ESG have been its environmental dimension, it has also been modelled as a catch-all paradigm for positive impact.

“Over a longer term, much of the mainstreaming of climate change in the financial landscape has been built off of the efforts of environmentalists and climate movements, including notably the fossil fuel divestment movement and Fridays For Future.”

The second concern, accordingly, has been the fragmentation and lack of standards over what exactly constitutes those ESG factors, leading to doubts about greenwashing.

Over a longer term, much of the mainstreaming of climate change in the financial landscape has been built off of the efforts of environmentalists and climate movements, including notably the fossil fuel divestment movement and Fridays For Future. Indeed, it is the toolkit of such movements that prefigures some of the responses to the Russian invasion. This range of responses harkens back to the boycott, divest, sanctions (BDS) campaigns used on apartheid in the 1980s, on the tobacco industry in the 1990s, on Israel in the 21st century, and was a major source of inspiration for the fossil fuel divestment movement.

This connection was also acknowledged in a Business Times editorial that, in calling the war in Ukraine a “turning point for ESG”, cites a former Ukrainian foreign minister who says that Ukraine could be “the 21st century equivalent of the late-20th century anti-apartheid movement, in which business, across many sectors and societies, banded together to counter the systemic and systematic racism of the white nationalist South African regime.”³

In all likelihood, calls for ESG-inclusion of weapons and defence stocks are not likely to be heeded. Pushback against these ideas have been strong. Weapons makers have major question marks over corruption and lobbying, and rarely lack funding.⁴Concerns about provoking an arms race are ever-present. But most importantly, efforts at standardisation are too far along to have to risk having to deal with the can of worms that defence weapons and war will bring.⁵

Implications for ESG

What does this incident tell us about ESG itself?

“By incorporating all three dimensions of environmental, social and governance criteria, and combining that with positive investment returns, ESG can claim to be all-encompassing. But in doing so, its all-encompassing nature leaves a number of critical questions open-ended.”

Firstly, it reiterates that ESG remains far too vague, unsettled and contested as a concept. By incorporating all three dimensions of environmental, social and governance criteria, and combining that with positive investment returns, ESG can claim to be all-encompassing. But in doing so, its all-encompassing nature leaves a number of critical questions open-ended. Is the goal to create positive impact, or simply avoid negative ones? How far can the claim to be ethical - a fundamentally subjective claim - be pinned down in a rigorous, objective framework?

For much of its history, the concept of ESG has been dominated by the looming threat of climate change. It combined this with the age-old bottom line of financial markets - that it had to make money for investors. But changes in the course of history can rapidly change what we consider to be ESG. This is why, following the global revulsion at Russia’s invasion of Ukraine, the cause of the weapons industry could lay claim to the virtues of ESG.

But this turns ESG into a set of imperatives that often clash with each other. As Matt Levine of Bloomberg points out, “If you’re an oil company, opening lots of marginal projects to drill lots of oil is bad for the environment, and something that your ESG-focused shareholders disliked a month ago, but it also reduces oil prices and so is good for Ukraine.”⁶

Ultimately, what is at stake in green finance is the allocation of capital. At the most basic level, green finance is geared towards shifting capital from carbon-intensive sectors to low-carbon sectors, but this objective was itself tied to a set of moral and financial claims. This means that it has always been fundamentally a political question. The significance of Ukraine is that it took a major war to bring the politics of ESG distinctly into view.

As Bloomberg columnist, Kate Mackenzie, points out, “The dumping of Russian-owned investments shows that sometimes the conundrum is resolved with breathtaking speed... When sentiment really shifts, assets can be stranded very quickly.”⁷It is a scale of change that environmentalists have been demanding for years, brought about only by the onset of war.

All this shows that what has always been lacking in green finance was clarity and focus. ESG, in its claim to be all-encompassing, seems especially ill-suited to provide that. In its place, what is needed is a regulatory framework on sustainable finance that finally puts the goal of a net zero economy front and centre.

footnotes

¹ Jeff Sommer, “Russia’s War Prompts a Pitch for ‘Socially Responsible’ Military Stocks”, New York Times, 4 March 2022, nytimes.com/2022/03/04/business/military-stocks-russia-ukraine.html

² Merryn Somerset Webb, “Are defence stocks now ESG?”, Financial Times, 4 March 2022, ft.com/content/9073a69f-bc90-4944-b9d9-d2a0a2ff1f15

³ “Ukraine may become a major ESG moment”, Business Times, 5 April 2022, businesstimes.com.sg/opinion/ukraine-may-become-a-major-esg-moment-0

⁴ “Week 13: So now weapons are acceptable ESG investments?”, ESG on a Sunday, 3 April 2022, esgonasunday.substack.com/p/week-13-so-now-weapons-are-acceptable

⁵ Michael O’Dwyer, “New body to oversee global sustainability disclosure standards”, Financial Times, 4 November 2021, ft.com/content/3fb80e89-4ce6-4cc8-8472-ae4c8c99b12d

⁶ Matt Levine, “ESG Goes to War”, Bloomberg, 10 March 2022, bloomberg.com/opinion/articles/2022-03-09/esg-goes-to-war

⁷ Kate Mackenzie, “To Divest or Not to Divest? Sometimes the Choice Is Made for You”, Bloomberg, 4 March 2022, bloomberg.com/news/articles/2022-03-04/to-divest-or-not-to-divest-sometimes-the-choice-is-made-for-you