Ukraine war reveals flaws in ESG investing

Russia’s invasion of Ukraine has rattled global markets and left investors grappling to understand the implications for responsible investing.

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The violent conflict and soaring commodity prices have forced investors who pride themselves on doing the right thing with their money to rethink their approach to ESG investments, said Aaron White, vice-president of sustainable investments with CIBC Asset Management.

Until recently, sovereign entities’ ESG analysis has been heavily correlated with GDP. Factors such as primary energy consumption, food security, labour freedom, human rights, political stability, government effectiveness and gender inequality are important for assessing a country’s ESG risk, he said, but that data is typically only available on an annual basis. 

ESG rating agencies have downgraded Russian assets significantly since the conflict began, White said. 

“Expect rating agencies to rethink the methodology that drives the ESG country ratings, and investment managers to develop more robust processes around their own evaluation of these risks,” he said.

The conflict will also have significant implications for energy markets with countries looking to address both energy inflation and energy security, White said.

Energy inflation will have short- to medium-term implications as countries deal with high energy costs, White said, and could lead to short-term policy changes such as extending the life of nuclear or coal plants.

On the energy security side, European countries are looking to both diversify gas supplies to be less dependent on Russia and to hasten the rollout of renewable gases such as hydrogen, he said.

“The conflict will have reverberating and long-term implications for accelerating the energy transition in Europe,” White said.

Canadian oil, which White said has long been shunned as dirty and expensive, will emerge as “a more secure and socially acceptable source of oil,” as Canadian firms have been ESG leaders relative to others.

The effects of energy inflation are also being felt in North America. “The oil price shock will rattle the North American consumer, which will likely increase demand for renewable energy and technology,” White said.

Historically there’s been a “green premium” for green sources of energy, but high oil prices are changing that, he said, and shifting consumer sentiment in the process.

While some analysts have used the conflict to suggest more fossil fuel production is required for energy security, White said the war is more likely to accelerate the global transition to clean energy.

“Where the long-term implications of climate change have been an effective motivator at forcing governments and corporations to implement net-zero ambitions, the conflict has created short- and medium-term benefits,” he said.

As a result, he thinks net-zero goals for 2050 are more attainable now.

“While investors in conventional energy have benefited in the short term, this may be their last hurrah,” he said.

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