DWS raid is a crunch moment for ESG

It’s really starting to feel like a critical moment for the sustainable investing space. Soaring fossil fuel prices have shone a harsh spotlight on the mediocre performance of many environmental, social and governance-focused funds. Explosive remarks from HSBC’s head of responsible investing have driven a heated public argument about the financial sector’s true willingness to tackle climate change. And this week, German authorities raided the asset manager DWS and said they were considering pressing fraud charges over its sustainability statements.

As I argue below, the DWS raid — which has triggered the resignation of chief executive Asoka Wörhmann — is a powerful warning to peers who continue to use ESG as a fluffy marketing tool. Also today, we dig into a bulging Moral Money mailbag to share the best reader insights on the debate triggered by the speech from HSBC’s Stuart Kirk at our recent summit. Have a good weekend. (Simon Mundy)

The cautionary ESG tale from Wöhrmann’s DWS

Asoka Wöhrmann took the helm of DWS in 2018 with a mandate to pursue growth for the newly listed asset manager as it sought to build a brand beyond that of its parent Deutsche Bank. He soon hit on a powerful means to that end: ESG.

“ESG is no longer just a ‘nice to have’ feature,” the Sri Lanka-born economist told the Financial Times the following year. “It has become part of an asset manager’s licence to operate.”

Under Wöhrmann, Frankfurt-based DWS rolled out a new “ESG integration” framework through which fund managers would seriously consider sustainability issues in investment decisions — a system that it soon said was being applied to about three-quarters of its managed assets. This focus on ESG was a core part of DWS’s pitch to investors. Its 2020 annual report mentioned the acronym no fewer than 720 times.

The strategy appeared to be working, with strong growth in assets under management. But a dramatic setback came last year, when former sustainability head Desiree Fixler — who was fired after just months in her role — alleged that DWS had serious flaws in its ESG strategy. She claimed that the company had badly overstated its strength on sustainable investing, with up-to-date data often unavailable to its fund managers — many of whom ignored ESG factors in any case. (You can read our recent interview with Fixler here.)

DWS has denied Fixler’s claims. But regulators in both Germany and the US have taken them seriously enough to launch formal investigations. This week the German probe began to look very serious indeed, when about 50 police officers raided DWS’s and Deutsche’s Frankfurt headquarters. The prosecutor’s office said it was exploring possible “prospectus fraud”, explaining: “Sufficient factual evidence has emerged that, contrary to the statements made in the sales prospectuses of DWS funds, ESG factors . . . were not taken into account at all in a large number of investments.”

That statement will send shivers up spines far beyond Frankfurt. Even after regulators launched their probes into DWS, some had questioned whether prosecutions could be brought around something as seemingly woolly and hard to define as ESG. “We struggle to see how regulators can hold DWS to account, because sustainability requirements are subjective, making it hard to enforce, even if there was wrongdoing,” analysts at Citigroup wrote last year.

German authorities have now made clear that they see very real scope to pursue fraud prosecutions over ESG claims. And while it remains to be seen whether they will do so at DWS — and what course the US probe will take — this week’s news should serve as an explosive wake-up call to any asset managers still using sustainability as a low-effort branding exercise.

Wörhmann — once seen as a rising star of European finance — will be out of a job next week, having tendered his resignation immediately after the raid. DWS had already dropped its vaunted “ESG integration” model and started using much stricter criteria for its ESG labelling, linked with European regulatory guidance. In March it reported €115bn in “ESG assets” for 2021, having claimed €459bn in “ESG integrated” assets a year earlier.

It may be too late for DWS to avoid the damaging fallout from its now-defunct ESG strategy. But it has been far from alone in making allegedly overheated claims about its sustainability credentials. Others should take note of this cautionary tale — and tighten standards before they have a whistleblower of their own. (Simon Mundy)

Your views on the Stuart Kirk furore

We are consistently impressed by the calibre of responses we get from the growing community of Moral Money readers, who play an important role in shaping our coverage. But your input on the explosive recent remarks by HSBC’s Stuart Kirk has been especially interesting. We thought we would publish some highlights, which give a useful perspective on some of the hottest points of contention in the sustainable investing debate.

Some readers saw the outcry against Kirk — who argued that investors need not worry about climate risks — as evidence of dangerous groupthink in the ESG space. “It is absurd that he was suspended for providing an analytical base to his thoughts and pushing people to really look at their assumptions,” wrote Margit Pearson from New York, warning of a “disappointing, and indeed frightening” herd mentality in this sector.

Others took issue with what they saw as a clumsy, irresponsible approach to a deadly serious subject. “It was an old man’s speech,” wrote Piers Gibson, arguing that such attitudes were looking increasingly absurd as concern about climate change grow among younger generations.

Several responses took issue with specific details of Kirk’s argument. Joel Moreland, a social and environmental finance consultant, noted Kirk’s reliance on models projecting strong long-term economic growth in the face of climate impacts — a widely held assumption that could prove dangerously imprudent, he warned.

Brisbane-based corporate adviser Alberto Melgoza observed the stark limitations of viewing climate threats through a financial risk prism. The worst impacts, he noted, would be felt in developing countries — often with little effect on global markets, but with a terrible human toll.

That ties into an argument made by several readers on the futility of relying on financial companies to play the lead role in tackling climate change. Peter Cosmetatos, chief executive of Commercial Real Estate Finance Council Europe, the trade association for the European property finance sector, put the point particularly forcefully:

It is true that for virtually any financial investment, risks that arise meaningfully (even if we discount the uncertainty) decades hence are essentially irrelevant . . . That isn’t to say that longer-term risks don’t matter; only that markets alone, working to the time horizons that they do, will reasonably ignore them.

Markets would properly price the physical risks of climate change only when it was too late, Cosmetatos said. That meant governments and supranational organisations needed “to act like the custodians of our longer-term interests they should be, and regulate”.

And yet by highlighting the contradictions and limitations of today’s flawed ESG sector, and fanning the flames of a badly needed debate, Kirk’s speech may well end up having a positive impact, several readers argued.

“These are the throes of a movement-turned-industry-turned-money-making machine growing up,” wrote Marcela Pinilla, director of sustainable investing at Zevin Asset Management. “The ESG/climate bubble has to burst, and here we are now, hopefully continuing to separate the wheat from the chaff.” (Simon Mundy)

Chart of the day

A new report from JUST Capital makes clear how far US companies still have to go in promoting racial equity, but also contains some signs of progress. Disclosure rates on some key metrics rose significantly, with more than 90 of the biggest 100 employers now reporting on workforce and board diversity. But fewer than a quarter of them disclosed race-linked pay ratios, and only seven companies gave a racial breakdown of their internal hiring.

Smart read

• For more on the hot story of the week, check out this FT analysis of the challenges awaiting the new man in the DWS hot seat: 42-year-old Deutsche Bank lifer Stefan Hoops. “The problem is that Hoops has no asset management experience at all,” says one leading investor.