(Bloomberg) -- The scandal gripping the Gautam Adani empire is turning into another bad milestone for ESG.
Stocks bearing the Adani name appear in more than 500 so-called Article 8 funds that are supposed to “promote” environmental, social and governance goals under European Union rules, data compiled by Bloomberg show. About 80 of those exposures are via direct holdings, while the rest are mainly through funds of funds or index trackers, according to the data, which correct for duplicate holdings.
As Adani entities get stripped from indexes and are placed under review amid allegations of fraud and market manipulation, ESG investors are once again left wondering why a strategy intended to shield against risks such as greenwashing and bad governance — often at an extra fee — didn’t protect them from the latest meltdown.
Since a Jan. 24 report by US short seller Hindenburg Research, the selloff in Adani stocks has wiped out about $127 billion in group market value. Funds with at least $10 billion in assets under management tracking MSCI ESG indexes held shares in Adani Enterprises Ltd. alone, according to an analysis by the Anthropocene Fixed Income Institute, which has been studying the Adani Group since mid-2020.
“Our view is that ESG investors with this unfortunate exposure should engage with their managers and, potentially, regulatory bodies that are better positioned to examine why this index-fund inclusion has occurred,” Ulf Erlandsson, AFII’s chief executive officer, and Stephanie Mielnik, its head of fixed-income research, wrote in a report on Adani published Feb. 9.
Patrick Wood Uribe, the CEO of Util, an ESG research firm backed by private equity and venture capital investors, said the Adani debacle exposes some fundamental flaws in the approach adopted by several ESG index and ratings providers, as well as portfolio managers.
“There can be a very large mismatch with what investors are expecting,” when they place their money in a company or a fund classified as ESG, Wood Uribe said in an interview. And by offering an “overly simplified view,” ESG ratings end up doing a “disservice” to investors, he said.
It’s the latest example of ESG investors getting caught out by the very risks they’re trying to dodge. A little under a year ago, ESG portfolio managers scrambled to escape their exposure to Russian assets as Vladimir Putin’s invasion of Ukraine triggered sanctions and a global selloff of stocks and bonds tied to his regime.
Back then, it emerged that ESG funds were exposed to everything from Russian state-backed oil and gas companies to bonds issued by the Kremlin. The episode was treated as a moment of reckoning for the ESG industry that some of its earliest proponents said should force a rethink of methodologies clearly not fit for purpose.
Article 8 funds are defined within the EU’s ESG investing rulebook, the Sustainable Finance Disclosure Regulation. The designation, which encompasses total managed assets worth €4.3 trillion, has faced criticism for becoming a catch-all that may be a good deal less ESG than many end investors imagine.
Part of the issue is that the EU’s requirement that Article 8 funds “promote” ESG is vague enough to allow for a wide range of interpretations.
In an effort to address such concerns, the European Securities and Markets Authority has proposed enforcing minimum thresholds that would require Article 8 managers to apply stricter standards to their ESG claims. A recent analysis by Morningstar Inc. found that if the ESMA proposal is adopted, only 27% of Article 8 funds would actually meet its sustainability requirement.
Adani companies were also held by 11 funds registered as Article 9, which is the EU’s highest ESG classification. Eight of these were through direct holdings, according to an analysis by Bloomberg. In order to justify an Article 9 designation under EU rules, a fund manager needs to prove that a portfolio is 100% sustainable, with allowances made for hedging and liquidity needs.
ESG fund managers are under “increasing pressure” to be “much clearer with investors about what exactly they are offering and what it means,” Util’s Wood Uribe said. There remains a “massive opportunity and a massive gap in actually meeting some of those sustainability objectives, actually delivering on what investors would like to see in terms of sustainable investment.”
Util also notes that Adani stock documents were replete with the kind of ESG verbiage that portfolio managers often look for. In its rebuttal of the Hindenburg report, Adani frequently cited the group’s adherence to ESG principles, and pointed to its adoption of multiple global ESG frameworks, including the Task Force on Climate-Related Financial Disclosures (TCFD) and Sustainable Development Goals (SDGs), among others.
Adani has consistently rejected the allegations of fraud, and reportedly engaged US law firm Wachtell, Lipton, Rosen & Katz to help fight the Hindenburg claims.
ESG ratings firms, meanwhile, have given some corners of the Adani group conspicuously high scores. Adani Green Energy Ltd. and Adani Total Gas Ltd. still carry an “A” rating at MSCI Inc., according to data on the website of MSCI. Adani Transmission Ltd. is rated “BBB.” All three have lost more than a third of their value since the Hindenburg report was published. A spokesperson for MSCI said the firm is due to conduct a review of its ESG and climate indexes, which may include changes as early as this week.
“This is a conglomerate with operations in commodities, utilities, gas, and airports” and one that is “engaged in some of the most controversial coal mining projects in recent history, including the largest open-pit coal mining operation,” Wood Uribe said in a written analysis of the Adani group.
“Thanks to the ‘convoluted structures’ and ‘multiplicity of subsidiaries’ cited in the Hindenburg report, Adani has long been able to finance its dirtier operations with the proceeds of sustainable fund flows,” he said.