This is an audio transcript of the Behind the Money podcast episode: Night School, Class 4: ESG reshapes the boardroom

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Peter Spiegel Welcome to Behind the Money Night School. Im Peter Spiegel. Im the US managing editor of the Financial Times. BTM Night School is a special series made in collaboration with Blinkist that will serve as a guide to the US economy in 2023. For tonights lesson...

Gillian Tett I think that most big companies today recognise they need to look at life beyond the balance sheet. But the question of how exactly you go about doing that is still being very hotly debated.

Peter Spiegel Were joined by Gillian Tett, founding editor of the Financial Timess Moral Money newsletter to talk ESG. Its become quite a buzzword for asset managers and public companies, but its not without controversy. Gillian will help us understand the future and the current fight over ESG.

Gillian, I will start with a very simple question. What exactly do we mean by ESG and how did it become an important part of the investment landscape?

Gillian Tett Well, ESG stands for environmental, social and governance issues, which sounds like yet another acronym that financiers love to invent. In practical terms, what it refers to is the idea that there is life beyond the balance sheet. And by that I mean that businesses historically, in line with the economist Milton Friedmans thinking, have tended to just focus on shareholders and profit and loss in a very narrow way. So what ESG is trying to do is look at all the other factors that businesses need to think about when they look at the risks in the world, like environmental issues, like social upheaval, like the idea that the governance inside the company may be so terrible that something could go wrong, et cetera, et cetera. So its really about trying to take a lateral view, a wider view of business, rather than the very narrow tunnel vision that dominated in the realm or the era of Milton Friedman.

Peter Spiegel So that sort of looking at a broader focus is, tends to be called stakeholder capitalism. So as you said, its not just shareholder, its stakeholder. So everyone who has a role in this. Is there evidence thus far that, do you think that ESG investing and stakeholder capitalism has had an impact on the US economy? I mean, are there signs that capital is flowing towards companies that are more environmentally or socially responsible?

Gillian Tett Well, I personally prefer to call it cleaner capitalism rather than stakeholder capitalism, because cleaner capitalism is both about trying to recognise the impact and role of the environment, but also thinking about sort of, you know, more transparent, decent forms of capitalism, much more widely in terms of the footprint on society. In terms of ESG metrics and performance in the initial wave of this movement some people claimed that ESG-friendly companies would be more resilient and have better returns. In practice, thats quite hard to prove either way. But what is clear is that they actually dont have worse returns than other companies. And more importantly, you are starting to see a wider dynamic where, because some companies are beginning to embrace these ideas, thats changing the wider landscape and expectations amongst investors and consumers and employees. And vice versa, those shifting social expectations are changing company behaviour as well.

So perhaps one tangible example of that is the American president Joe Bidens Inflation Reduction Act, which has emerged amid a recognition that there needs to be a lot more investment in green, renewable technologies. Thats something that some companies have been embracing for some time. But the very fact youve got the IRA coming down the tracks is actually accelerating the focus inside many corporate boardrooms.

Peter Spiegel You mentioned the Biden administration as a driver here, but one of the other earlier, I guess, players in this were the asset managers, particularly BlackRock, which is the biggest asset manager in the world. Let me ask you how important it is that some of these big financial services groups have been publicly advocating for ESG policies for several years now?

Gillian Tett Well, basically what BlackRock has done is to help put these issues centre-stage in many corporate boardrooms across America. And BlackRock itself has been channelling more capital towards ESG-friendly companies in parts of its portfolio. And I say a parts of its portfolio because this really relates to active investing, not passive investing. And of course, a lot of what BlackRock does is passive investing. But the fact that people like Larry Fink have been talking about these issues for a long time has not only helped to accelerate the movement and drive to measure these issues inside corporate balance sheets, which is absolutely critical. Its helped to enthuse an entire generation of younger financiers to train to understand these issues and get involved as well.

And most importantly, its made very clear to corporate boardrooms that if they ignore these issues completely, there could potentially be a cost in that groups like BlackRock may be less willing to fund them or invest in them. Now, theres now been a backlash against that on the American right. And so the situation has become more complicated. But whats very clear is even amid the backlash against what people like BlackRock have been doing and saying, there are very, very few corporate boards today that are ready to ignore these issues completely because for many of them theyve become part of a risk management toolkit that they feel they cant ignore or essentially suffer.

Peter Spiegel So you mentioned the backlash. I want to get to that. But before we get to that, I want to talk about other players in this field, because you mentioned the Biden administration. Weve talked about the asset managers. What are the other sort of groups out there, have been some central banks who have sort of wade in and tried to talk about the stress testing, based mostly banks and financial solutions for climate exposure, for instance. What impact have central banks had in some of this debate and in the cost of capital for, I guess, brown industries?

Gillian Tett Well, theres essentially two key ways that central banks have got involved. On the one hand, they have, in some occasions, particularly in Europe, said theyre gonna try and use their own massive investment pools and asset management policies to try to promote a green agenda. So thats really about trying to avoid investing central bank assets in dirty assets like oil and gas bonds and channel that money instead to cleaner assets. Now, thats quite controversial but its certainly one way that central banks can get involved.

The second way theyre doing this is to look across the financial sector and require the companies that they supervise to think about it in their accounts as well. Now, they can do that for ideological reasons if they think that its important to accelerate the green transition. They can also do it for straightforward risk management reasons because if you are, say, supervising banks in Florida, its kind of nuts if you dont take account of the fact that there could be more flooding in the future because of climate change. So there is a financial stability frame for this whole debate, which is being very actively discussed and picked up and central banks are getting better and better actually in monitoring this. And that in turn creates a feedback loop whereby that encourages banks themselves and the other institutions they supervise to get better at this as well.

Peter Spiegel All right. One last group I want to talk about before we get to the backlash, and you wrote quite a bit about this at the time, but the Business Roundtable weighed in saying that it wanted to rethink the way capitalism was done. Talk a bit about the Business Roundtable. Who are they? When they announced this shift, what impact has it had?

Gillian Tett Well, the Business Roundtable are basically Americas biggest companies. And when they came out and announced this shift, it was symbolically incredibly important because since 1970, when Milton Friedman wrote his role landmark essay about shareholder-first capitalism, the vast majority of business executives have been trained at business schools and other places to really absorb and adopt and apply the Friedman vision of the world. And the Business Roundtable tended to echo that too, really focusing on shareholders only.

So the fact that the BRT came out in the summer of 2019, is that actually there is also another way of looking at it, stakeholders was symbolically very important. But and thats a big but its very unclear the degree to which the CEOs who actually made this announcement really understood what it meant or had thought through all the implications. One indication of that is that subsequently a number of them have tried to, if not back down from this, but just try to perhaps water down some of the commitments, what they mean.

However, I dont see anybody on the corporate landscape right now who is saying that they want to return to Milton Friedmans vision of the world and just look at shareholders. So even though youre seeing some backlash against ESG right now, youre not seeing a return to the really narrow 1970s Milton Friedman vision, which raises the really big question of what next? I think that most big companies today recognise they need to look at life beyond the balance sheet, think about ways of making capitalism cleaner to make it more durable. But the question of how exactly you go about doing that is still being very hotly debated.

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Peter Spiegel Well, lets get to the debate right now because you flicked at this before, but this issue of the backlash and the numbers that people who are in this field right now... we just went over Americas biggest CEOs, central bankers, asset managers like BlackRock and Larry Fink. Those dont seem to be a list of leftwing radicals if you were to line them up. And yet, over the last six months or so, youve seen this backlash where Republicans in both Washington and in state capitals have attacked ESG as sort of, quote unquote, woke capitalism. Talk a bit about what their argument is and how influential theyve been.

Gillian Tett Well, its actually, there are two main reasons that have caused this big backlash right now. One is the energy crisis and the war in Ukraine, which has basically prompted a lot of politicians to say, actually, we cant afford to go too green too fast, or else ordinary people will suffer. And in many ways, thats entirely understandable. The second reason is that you have on the American right, this idea of, quote, woke capitalism has been very convenient for them. Its very easy to whip up a lot of, you know, feeling and protest around ideas that youre focusing too much on identity politics or things like that at the expense of hardcore, proper business. Thats very much the kind of line.

Now, what youre seeing happen is a lot of very powerful oil and gas companies and wealthy rightwing individuals funding very heavily these campaigns against ESG, both at the state level, where a number of state legislators in the rightwing states have been essentially passing measures to try and hobble ESG, but also at the federal level, where youve got a huge fight developing, or has developed around the Department of Labours rules, which essentially permit at the moment asset managers to incorporate ESG if they want.

Youre also seeing a huge battle around the Securities and Exchange Commission, which have proposed rules to try and bring the accounts into line with, say, the European system by encouraging companies to actually take note of ESG issues, particularly climate issues in their accounts. So you have this multipronged campaign from the American right against ESG.

But whats really striking is that although thats made some CEOs very reluctant to talk about these issues in public...I sometimes talk about the idea that the issue in the corporate world right now is green hushing people not wanting to talk about green issues not so much greenwashing. Although youve got a lot of green hushing going on, you are also seeing, for the most part, corporate boards very quietly moving ahead with some elements of the ESG agenda, even if theyre not talking about it. And very few are dropping it completely.

Peter Spiegel Well, let me ask you to follow up on that. I mean, do a little bit, if you dont mind, crystal balling. I mean, given what you were talking about, the Ukraine war, putting energy security maybe higher on the agenda perhaps than the green economy, and as you say, this sort of green hushing where corporate leaders dont want to talk about it anymore. Try to do a little bit of forward looking. Where do you think the ESG movement goes from here? Are we going to continue to see investment flowing more towards good corporate citizens, or are both of those factors slowing things down or even putting things in reverse?

Gillian Tett Well, I think youre going to see probably the ESG label used less and less because that is controversial. Some people think its too formulaic, some people dont like putting the E, the environmental issues, together with the S, the social factors. So those are all issues which are making the ESG label a bit more controversial. And thats even before you get to the rightwing backlash. But I dont think youre gonna see a return to Milton Friedman for three reasons.

One is that Milton Friedmans ideas about companies just focusing on shareholders and ignoring everything else came out of the time after World War Two when there was high public trust that governments could do things, and they were presumed to be the main people who had to fix environmental and social issues. Its radically different today. All of the surveys show that trust in government to actually do anything is much lower, if not rock-bottom low, than before. And as a result, the surveys also show that the publics looking to companies to actually try and address social issues. Secondly, youve got a real changed climate risk of trust in that people no longer trust authority figures as much as they used to. They trust the crowd. And if companies ignore the crowd and they do so at their peril, and if the crowd is changing their attitudes on issues like ESG, its very hard for the corporate board to just ignore that. Which leads me to the third point, which is we also live in a realm of radical transparency. I mean, when Milton Friedman developed his ideas in the 1970s, it was really hard for ordinary people to have the faintest idea of what was happening inside companies. Now you have websites like Glassdoor telling you whats really happening inside companies. Youve got, you know, employee chat rooms, youve got NGOs, youve got satellites, tracking company emissions, things like that. So any corporate board today has the ever-present threat of a reputational scandal exploding on their watch if they ignore this.

I dont know what form exactly this is gonna take, but its really striking that if you talk to corporate boards today, Ive yet to find a single one thats willing to say were totally ignoring climate change and those issues, for example.

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Peter Spiegel Let me round out our conversation by talking, as you said, ESG is not just E. Sometimes we talk mostly about environmental, but there is S and G. And lets talk about S and G at the end here. Social issues, because that is in many ways at the core of the backlash. And Im wondering whether the recent political polarisation over things like abortion and gun control has that complicated efforts of ESG advocates to get a consensus around what should be done?

Gillian Tett Well, the fact of the matter is that the social issues are usually viewed as part of a progressive agenda, but theres a quite wide range or spectrum of social issues. You know, one end of the spectrum view has racial justice and LGBT rights, which those in the right wing say that companies should not get involved in. You also got issues like abortion rights, which some progressive companies have taken a stand on. But again, thats controversial.

At the other end of the spectrum on the S are things like the idea that you shouldnt kill your employees on the job because of lack of safety standards. You shouldnt engage in sexual harassment. You know, you shouldnt be basically paying people such a terrible wage that they cant actually live on it. And those issues actually are often less controversial and embraced by some companies, which you would think would actually have a rightwing agenda. Because another way of framing whats going on is trying to build a picture of companies that arent ultra-exploitative of workers, but trying to actually nurture them and act as stewards of their workforce and stewards of their environment for a long-term future. And that type of vision is something that a number of conservatives can get behind. It might sound a bit paternalistic, but that is something which chimes quite well on the American right.

Peter Spiegel Lets wrap up by talking about G. And by governance we mean corporate governance. And this is not really an issue that is new to ESG. Weve had proxy advisers and other corporate watchdogs who have flagged some of these issues for some time. Has the ESG movement sort of accelerated that? Has it had an impact or are we still sort of in the same place where some companies do it better than others?

Gillian Tett Well, I think the G issue has been obviously around for a long time. And in some ways it sits a little bit oddly within the ESG complex because its really about the internal processes of a company and not about the companys footprint on the world around it or the impact of the world on the company. But another respect is actually critical to the whole concept, because if a company is run very badly with no transparency, no risk management, and just one mercurial, you know, CEO, then its likely to have a much worse footprint on the world than others and likely to essentially be ill-equipped to cope with a changing environment. So I think people in the ESG space are increasingly looking at the G and saying that companies need to be well-run, not, you know, treated like individual fiefdoms.

And another way of putting all this is to go back to Adam Smith, whos seen as the father of modern capitalism, and look at the fact that, you know, he wrote his book about the powers of free-market competition to drive progress and growth, The Wealth of Nations. But he also wrote a book called The Theory of Moral Sentiments about the fact that commerce and capitalism works best when you actually have a shared set of values and trust in society and where companies are run by people who feel they have skin in the game and a sense of responsibility in terms of building their businesses. Now, that sounds incredibly obvious. Its amazing how often that has been forgotten. But in many ways, that is part of the focus of G.

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Peter Spiegel Gillian, Im gonna put you on the spot here. If there are three takeaways that our listeners should get from this conversation when theyre thinking about ESG in the US economy, what would you put as the top three?

Gillian Tett Takeaway number one is that ESG these days is about risk management. Not really about a pious, do-gooding desire to change the world. Second big takeaway is that there is now a backlash against this, which is creating real headaches for corporate investors and corporate boards because anybody who wants a unified policy across America today, let alone across the Atlantic, finds it very hard, given the different attitudes to ESG. Three, in spite of this backlash, I dont think were going back to Milton Friedmans narrow vision of shareholder-only capitalism. But its still unclear exactly where we are going to now.

Peter Spiegel All right. Now Im really gonna put you on the spot. One big takeaway, again for our listeners, were just about to wrap up here, are thinking about ESG and they walk away. What would be the one thing you think they should keep in their mind?

Gillian Tett You ignore the zeitgeist, change at your peril.

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Peter Spiegel You can find Moral Money and more of Gillians writing on FT.com. This episode was done in collaboration with Blinkist. If you want to find more conversations on topics like this, check out the Blinkist app. This episode was produced by Zach St Louis. Topher Forhecz is our executive producer. Sound design by Breen Turner and Sam Giovinco. Cheryl Brumley is our global head of audio. Thanks for listening. Class dismissed.

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Night School, Class 4: ESG reshapes the boardroom - Financial Times