ESG principles have been growing in prominence as their application becomes more essential to investor decisions, and for the businesses throughout the world that are working to adhere to an evolving array of environmental, social and governance framework principles. The path forward must include balanced, flexible and globally aligned approaches.
Accordingly, ESG is playing a decisive and growing role as a wide range of stakeholders engage in portfolio analysis. Consequently, as investment decisions are made, they ultimately affect portfolio returns and even the cost and allocation of capital. Although there are almost $4 trillion of institutional assets now invested in ESG portfolios, it’s critical to note that ESG is still growing and in its relatively early stages of evolution.
Every company that has a vested interest in ESG recognizes that to achieve the benefits investors are seeking, that balance, flexibility and global alignment of ESG metrics and reporting systems must be achieved. However, currently evolving and sometimes inconsistent investment guidance is creating difficulties when comparing metrics across global business sectors and under the variety of confusing regulations and complicated performance frameworks.
While every industrial sector is in ESG learning mode and adjusting approaches and strategies to achieve compliance and validation of their sustainability, there are two sectors that are the subject of particular focus and scrutiny: energy and aerospace defense. Along with them are their supply chains of global services, manufacturers and government contractors that support those sectors and that also risk being drawn into confusing ESG evaluations.
Let there be no doubt, both of these sectors are absolutely critical to maintaining global economic and national security. However, due to the nature and perceptions of the work which companies in these sectors undertake, investors have now begun to shun these industry sectors, and maybe even more disconcerting, their access to financing is being restricted and becoming more expensive.
In fact, calls for the Federal Reserve Bank to address and engage on financial risks posed by climate change could well begin to restrict lending to energy sector interests. These unintended, but potentially dangerous consequences are largely a result of well-intentioned but misguided ESG frameworks.
Additionally, so-called negative screening processes actually tend to punish companies in these sectors even as they continue to do the necessary work expected of them in their respective areas, such as energy production and distribution, and the development of military equipment and defense systems.
Yet consistent with ESG sustainability and net zero climate objectives, but somewhat less apparent to investors, both the energy and the aerospace/defense sectors are already investing billions of dollars in sustainable energy projects, carbon capture, alternative fuels, electric vehicle technology and even cybersecurity risk reduction. It’s imperative that these sectors continue to advance these projects and technologies.
To do so, however, access to investors must be ensured, along with affordable financing that will sustain ever-expanding global energy demand and support continued production of the advanced technologies needed to meet the wide range of rising global threats and security needs.
Now is the time for companies and regulators across the globe to collaborate, build consensus and seriously consider how ESG principles are being framed and communicated. Going forward, the path must also comprehend the use of inclusive ESG integration funds specifically designed for these sectors. This will work to build investor and stakeholder confidence in ESG and will ensure that energy and aerospace/defense sectors continue to attract the necessary levels of investment and financing needed to guard global economic growth and national security.
To that important point, Alessandro Profumo, ASD European trade federation president, and chief executive of Italy’s defense champion, Leonardo, recently said it best: “Without security we cannot have sustainability.”
With that in mind, we have the responsibility to take the steps needed to advance and align the ESG principles that will secure and sustain the planet today, that we are trying to save for tomorrow.
Michael J. Roman is a senior fellow for public policy and ESG at the American Council for Capital Formation and president of CertainPoint Strategies.
