Legitimacy and the extraordinary growth of ESG measures and metrics in the global investment management industry

Abstract

ESG metrics are increasingly important in the global investment management industry. Why this came to pass given the limited appetite for responsible investing in the industry is the subject of this paper. Although the business case for ESG provides an explanation for its increasing uptake whereby market actors are increasingly convinced of the merits of ESG as a profit centre, this explanation is insufficient. By contrast, the adoption the ESG programme offers a means of rewriting the terms of risk management and value creation that while grounded in the business case also serve to address challenges to the legitimacy of the global asset management industry. These developments are illustrated in a case study of the establishment and growth of TruCost and its purchase by S&P Global in 2016.

Introduction

The global investment management industry is increasingly embracing climate change, moving from marginal commitments to investment strategies, metrics of performance, and market solutions that, at the limit, involve the disinvestment from companies that have been resistant to changing their business practices. Consider, for example, the announcement in 2021 at the 26^th United Nations Climate Change Conference (COP26) in Glasgow of a new coalition of international finance companies: the Glasgow Financial Alliance for Net Zero, led by the former central banker Mark Carney. This group of more than 450 asset managers, banks and insurers from 45 countries, committed to channelling capital to help countries achieve net zero over the next decades. ¹ These could turn out to be hollow commitments with little material effect. Notwithstanding such speculation, the scale and scope of this initiative coupled with comparable proliferation and growth of cognate initiatives such as the Principles for Responsible Investment and the Net Zero Asset Managers point to the mainstreaming of sustainable finance as a core theme in financial practice and financial markets.

Although the mainstreaming of climate change as a fundamental area of concern in investment decision-making is a recent development, it has been in the making for many years. Twenty years ago, ESG (environment, social and governance) initiatives were often labelled as ‘ethical’ and/or ‘responsible’ investing and were thought to involve a compromise on benchmarked expected rates of return (Statman, 2020). Indeed, the existence and significance of a discount on returns has been disputed by academics and the world's largest asset managers (Clark et al,. 2015). Even supposing that what constitutes ‘sustainable finance’ remains contested and is practiced differently from one firm to the next and differently across countries and regions, as recent debates in the European Union highlight regarding the inclusion of gas and nuclear energy investments in the bloc's taxonomy for sustainable activities, the ESG market globally is expected to be worth $53 trillion by 2025, or a third of all assets under management (Bloomberg Intelligence, 2021). ESG is moving beyond a niche area of concern, becoming a key element of the emerging, if ultimately aspirational and still highly contested, carbon-neutral regime of asset manager capitalism (see, e.g., Braun, 2021; Christophers, 2021; Felli, 2021; Newell and Paterson, 2010).

The challenge for asset managers is, however, in producing coherent and integrated ESG strategies that go beyond net-zero (2050). ² Large investment companies have typically responded to the climate change agenda by adding ESG considerations to existing investment strategies rather than changing how strategies are conceived and implemented. Another response has been to introduce investment strategies and products that seek to take advantage of new ESG metrics and measures of performance. And yet another response has been to develop investment products that have at their core the assumption that investing in environmental futures will be rewarded by long-term rates of return over and above those available in the market. In this paper, we are principally concerned with the first and second ESG-related strategies.

ESG measures and metrics are typically used in risk management and are assumed to generate value over the long term. As such, proponents of ESG have stressed that it is based on financial and environmental fundamentals. Friedman's (1970) aphorism that legitimated profit-seeking at the expense of a broader interpretation of the role of corporations in society has lost its ‘bite’ (Hart and Zingales, 2017; Lund, 2021). Even so, his claims about the proper purpose of the corporation are still invoked by defenders of the status quo notwithstanding ‘corporate virtue signalling’ (Ramaswamy, 2021). ³ Indeed, the state of Texas, the largest oil and gas producing region in the United States, recently accused ten listed asset managers, including the world's largest Blackrock, of ‘boycotting’ the fossil fuel industry. This designation could lead to state-sponsored pension funds divesting from these asset managers and their services. In announcing the list, the state's comptroller Glenn Hegar stated that the ESG movement ‘has produced an opaque and perverse system in which financial companies no longer make decisions in the best interest of their shareholders or their clients’. ⁴

Underwriting ESG activities in the language of maximising long-term value, the global investment management industry is attempting to bypass Friedman (Lund and Pollman, 2021). They are also responding to growing demand from clients for ESG. Although the business case for ESG provides an explanation for its increasing uptake whereby market actors are increasingly convinced of the merits of ESG as a profit centre, this explanation is insufficient. ⁵ In this paper, by contrast, we interpret the emergence of ESG and its recent embrace by the global asset management industry as being, in addition to the business case, the result of apparent shortcomings in the integrity and practices of the global investment management industry (Morris and Vines, 2014). If coming from a slightly different angle, our argument chimes with Leins’s (2020, 73) argument that ESG, ‘became a technique for harmonising the ethical order of the market’ (see also, Parfitt, 2020). Comparable to Arjaliès (2010, 57), we see ESG as a social movement that has emerged in response to legitimacy crises of contemporary capitalism and financialised society.

Whereas 20 years ago, the industry may well have sought shelter with government from these challenges to its legitimacy, it is apparent that many governments are ill-equipped to deal with these issues let alone the problems faced by the finance industry in justifying itself to civil society. Indeed, the industry's embrace of climate change and responsible investment likewise has not been reliant upon government regulation or support; as some have noted, ESG is a form of privatised neoliberal governance (Thistlethwaite and Paterson, 2016). In short, we regard moves to embrace the environment, the ESG movement, and responsible investing as a means to bolster the legitimacy of the industry. This is not, and our analysis should not be read as such, a claim about the effectiveness of sustainable finance in addressing climate change relative to the nature and scope of the issue (see Tallarita, 2021). Indeed, as Christophers (2019) has shown, there is evidence to suggest that institutional investors will not react to new informational indicators of climate-related risk, with fossil fuels likely remaining a locus of investment for a long time.

The global asset management industry is, predominantly, an Anglo-American industry (Clark and Monk, 2017). ⁶ As such, the empirical focus of this paper is on ESG initiatives anchored in London around the year 2000 and their incorporation into New York markets through the second decade of this century. The vitality of the market development of ESG is illustrated by a case study of TruCost – an arguably iconic data services company that was established by entrepreneurs who believed that ‘good’ corporate governance is associated with cost-effective environmental stewardship. Taking TruCost as a crucial case, it established methods and metrics by which corporate ESG performance could be measured, kick-started the global market for ESG metrics, and demonstrated how ESG metrics could be incorporated into investment strategy. In the space of 20 years, TruCost went from being a London-based start-up to the centre (New York) of the global asset management industry through its purchase in 2016 by S&P Global, one of the world's largest purveyors of financial information and analytics.

We construct the argument as follows. In the next section, using specific cases and instances of malfeasance, we explore the legitimacy of finance and its ongoing contestation and instability. This sets the scene for understanding how the entrepreneurs that saw a business case for ESG metrics did so in a context where the societal purpose of finance and the role of asset managers was (and continues to be) increasingly put into question. Before presenting the TruCost case, we present the industrial dynamics of the global asset management industry. This provides a basis for understanding how the market for ESG began as a niche interest driven by entrepreneurs (rather than regulation) to eventually taking hold in the largest asset managers and service providers. We then relate the story of TruCost. The penultimate section reflects on the case and the legitimacy question as pertains to the development of ESG and its recent mainstreaming. In the conclusion, we note that governments are increasingly focused on the ESG industry, with recent regulatory initiatives announced by the European Union, the United Kingdom and the United States. Whereas questions can be asked about the integrity and effectiveness of ESG metrics, it is arguable that governments and public agencies have cloaked themselves in the ESG mantra to share in the success of these initiatives and their widespread acceptance.

The legitimacy of finance and ESG

Western governments, in aggregate, have been slow in bringing forward policies and regulations that would accelerate solutions to the climate change crisis. On environmental matters, there are questions about the legitimacy of liberal democracies and the nation-state in the 21st century even if there remain significant differences between countries in their willingness and capacity to address these challenges. Western governments have tended to deflect responsibility rather than carry forward the climate change agenda with policies that match the significance of the problem. In this respect, lack of commitment and regulation has provided the global financial services industry an ‘open space’ for its ESG market initiatives.

With respect to the legitimacy of liberal democracies, there is a large and growing literature on legitimacy animated, in part, by political philosophy – past and present (see Urbinati, 2008 linking Hobbes, Kant and Rousseau to Madison and Burke amongst others). In acknowledging this legacy, the legitimacy of contemporary liberal democracies is found in a shared commitment to enforcing the ‘rules of the game’ as they pertain to ‘social well-being’ (now and in the future) notwithstanding the existence of competing and justifiable conceptions of ‘social well-being’ and the meaning and application of the ‘rules of the game’ (Fallon, 2018). Climate change is an existential challenge to ‘rules of the game’ and what we mean by ‘social well-being’ in that the status quo is part of the problem (Stern 2006). ⁷

In principle, the legitimacy of any industry including finance resides with government. Anglo-American societies rarely proscribe companies and/or industries. Rather, the establishment and existence of a company along with its activities is set within a permissive legal framework. Public and private actors create companies for their own purposes so long as the activities of these companies do not violate established laws and regulations. Over the past 100 years, proscribed companies have come from the alcohol and tobacco industries, asbestos, gambling and, more recently, opioid makers.

Governments typically control the process of incorporation, the form of incorporation, and who are eligible to be corporate directors and officers. In most cases, governments do not specify the purpose of a corporation but require a statement as regards its purpose. There is, moreover, a market for incorporation. In the United States, the state of Delaware provides relatively high standards of incorporation with respect to protecting the interests of investors and/or shareholders. In other cases, incorporation comes with secrecy and limited disclosure. Offshore financial centres have used these devices along with the preferential tax treatment of earnings to garner an outsized share of the global financial services industry (Haberly and Wójcik, 2015).

More generally, corporations are often treated in law as ‘fictive’ persons in that they are accorded the economic entitlements of persons as enshrined in countries’ constitutions, statutes and/or common law. This right is often circumscribed and policed by governments, especially in circumstances where the capabilities and resources of corporations far outweigh political parties and citizens. One exception is found in the United States, where the US Supreme Court through Citizens United v. Federal Election Commission 558 US 310 (2018) expanded the rights of corporations to act as political ‘persons’ thereby undercutting the process of partisan debate and engagement (see Klarman, 2020 on the parlous state of US democracy).

Governments regulate companies, the behaviour of their officers and employees, the nature and scope of relationships with third parties and intermediaries, and their obligations to society including the payment of taxes and standards of transaction. Regulation comes in many forms. It can be prescriptive, focused on specific types of transactions and attentive to the nature and scope of corporate governance including the actions taken by senior executives, the oversight of boards as well as roles and responsibilities of corporate officers. Regulation can be limited in scope thereby relying upon the market for corporate control to provide the discipline necessary to protect employee, shareholder and social welfare.

In recent years, the legitimacy of the corporation and, specifically, the legitimacy of financial companies and institutions has been questioned (e.g., Palley, 2014). At the most general level, the legitimacy of finance has been questioned by those who associate finance corporations with partisan political interests to the detriment of industries and regions, specific groups of individuals such as low-income earners and the environment (e.g., Nölke, 2020). In this respect, the finance industry has not been able to find shelter under the wings of government and, more generally, the constitutional architecture of democratic societies. Evident shortcomings in contemporary democracies have revealed the limited salience of totemic ideological claims in favour of capitalism over communism.

The legitimacy of finance has been undercut in small and not-so-small ways and is evident in everyday life in various ways. We highlight four examples below. In the first example, many people accused the industry of self-interest and greed. In the second example, it is apparent that self-interest and greed are not just personal (agent specific) – it is representative of widespread behaviour (the Madoff case). In the third example, investment groups have been shown to exploit both sides of the market in their own interests notwithstanding adverse consequences (AIGFP). And, in the fourth example, systemic tendencies of financial crisis translated into significant welfare consequences for individuals and the public at large.

There are many instances of individual greed, self-interested dealing and short termism in finance companies. Take, as one example, the case of Mohammed Ali Rashid, an investment manager at Apollo Management LP (New York). In US federal district court, it was found that Rashid had, ‘fraudulently claimed that personal expenses were business expenses and were thereafter paid by private equity funds advised by Apollo and Rashid’ (SEC v. Rashid WL 5658665, 23 September 2020). More problematic, the court found that the company failed at a rudimentary level to supervise Rashid and ensure that he abided by the company's rules when charging for investment services. While specific to Apollo Management, it is indicative of systematic failings across the industry.

A stand-out example of individual interest and corporate failure is the Madoff scandal (Lionel, 2017). Bernard Madoff, as CEO of the investment company he founded, had operated for many years in what amounted to a Ponzi scheme. In doing so, he attracted gullible clients drawn to higher-than-average returns with little or no volatility. His unique claims of success were sold to clients around the world through intermediaries that advertised access to a once-in-a-lifetime opportunity. He avoided large corporate clients in favour of smaller companies that specialised in individuals and families of high net worth. Using bogus data, he advertised a level of accountability where none existed.

More profound are cycles of market speculation fed by the self-interested activities of investment companies selling value propositions to large and small investors. A case in point was the role of AIGFP (American International Group Financial Products) in bringing to market in the mid-2000s risk-rated tranches of US mortgages that were sold to institutional investors for a premium over the risk-related return available through standard market indices. As discount rates have slowly but steadily declined over the past three decades, these types of ‘deals’ have been attractive to major investors who compete to access these value-based opportunities. These deals were sold to institutional investors around the world. With the bankruptcy of Lehman Bros in London, market volatility was transformed into a global financial crisis and recession (Haldane and May, 2011) whose effects persist to this day (Leonard, 2021).

Finally, over many decades, global investment companies designed and sold investment products without regards to their ethical and/or moral value justifying their behaviour directly or indirectly by reference to the theory of efficient markets (Fama, 1970). So, for example, the ‘added’ value of some global equity portfolios is found in tobacco stocks whose companies reach-out to developing markets to enroll successive generations of consumers in a fundamentally unhealthy habit. ⁸ More recently, the detrimental consequences of fossil fuel investments for global climate change have been justified by the rate of return on these stocks and claims to the effect that ‘ethical’ investment is a losing proposition that violates fiduciary duty (Raghunandan and Rajgopal, 2022; Rubenfeld and Barr, 2022).

In the first example above, Apollo Management could blame a rogue employee even if commentators use this type of case to represent commonplace industry practice. In the second example, the CEO (Madoff) of a private investment company ‘sold’ a story that was based upon a fantastic lie. In the third example, financial institutions (AIGFP) packaged and sold risk to the market thereby precipitating a global financial crisis and a deep and persistent world recession when those risks became systemic rather than idiosyncratic. In the fourth example, critics of the financial services industry argue that its investment practices are immoral and are a threat to humanity.

The global asset management industry is, hence, criticised for self-interested behaviour, systematic market manipulation, leverage that threatens financial stability, and the touting of financial products that threaten human health and well-being (Morris and Vines, 2014). As such, understanding why the industry has embraced the ESG movement needs to be seen in this context. The embrace of ESG is an opportunity to reframe its own legitimacy, particularly in the absence of government regulation (rules of the game) and government requirements to enhance our collective environmental future (social well-being) (see also Arjaliès, 2010). Equally, there are reasonable grounds for disputing the net impact of ESG investing – for some critics, ESG investing is window dressing and worse (Christophers, 2019; Dal Maso et al., 2022).

In Leins’s (2020) ethnography of ESG implementation at a Swiss bank conducted shortly after the global finance crisis, such window dressing is palpable amongst some agents. He notes that the management of the bank saw ESG as, ‘a way of providing ‘responsible investment’ solutions without having to deviate from the profit-driven approach of existing investment strategies’ (Leins, 2020, 80). ESG, in Leins's interpretation, became a narrative device for financial analysts to sharpen, positive or negative, their advice on the buying or selling of companies (see also, Arjaliès and Bansal, 2018). As Leins notes further (2020, 87), ‘at a time when responsibility became more explicit in public discourse, ESG succeeded in integrating a critique of capitalism into valuation practices while at the same time adhering to this spirit of calculation’. As he concludes, (2020, 87), ESG is part of a, ‘post-crisis ethical order of the market that exploits social contentions and crisis-related discourse in order to create new speculative opportunities and profit’.

Industry structure, innovation and consolidation in investment management

In this section, we provide a brief introduction to global investment management industry focusing upon the role and status of financial intermediation in advanced capitalist economies. This is relevant for understanding the TruCost case below where ESG emerged as a niche sector to eventually becoming central to data provision for the asset management sector. We begin with the concept of financial intermediation. That is, the claim made by many financial theorists that mobilising financial assets, investing those assets and realising a rate of return against viable alternatives are important, even fundamental, activities of the industry. Put slightly differently, these functions are essential in mobilising financial assets and realising rates of return that have benefits for private investors (clients and beneficiaries). As indicated in the previous section, the process of financial intermediation has a legitimacy problem if its benefits are captured by elites at the expense of the common good.

The standard explanation for the existence of financial intermediaries such as banks, credit unions and the like is that they serve a purpose. That is, they are the means of switching assets from those activities that generate a surplus to those activities that can use these resources to give effect to their goals and objectives (Mayer and Vives, 1993). In short, intermediaries facilitate the flow of capital from savers to borrowers. It has been argued, for example, that English Industrial Revolution was financed by surpluses generated in agriculture and trade. The switching process was orchestrated by banks and other types of organisations that, in effect, redeployed agrarian wealth to the emerging cities and regions of the industrial revolution.

The intermediation process is viewed, by some, as unproblematic in the sense that its form and functions are entirely obvious. However, King and Levine (1993, 156) argue that financial intermediaries should be ‘viewed as playing an active, perhaps dominant, role in the organisation of industry. With their actions, they determine which organisations will survive and which will perish …’. More recently, Merton and Bodie (1995, 2005) argued that the form of intermediation is just as important as its function – some types of intermediaries are more efficient than others. Competition between different types of intermediaries is a necessary ingredient in ensuring that the intermediation process adds value rather than subtracting value from the owners of assets and the public at large (see Dixon, 2011).

There are three elements of this process evident in the 21st century global investment management industry. First, there are multiple sources of ‘surplus’ savings often with different objectives and investment time horizons. Second, self-investing, more-often-than-not, is a losing proposition compared to employing others more skilled and knowledgeable and with deeper pools of assets. Expertise and economies of scale matter. Third, investing is about time and space. The pooling of assets and their placement in investment vehicles is a global process that privileges some markets more than others. Facilitating both are electronic systems of communication and transaction that can take assets from Johannesburg and place them in London with the click of a mouse. Economies of scope matter.

Historically, the switching process relied upon banks and similar types of organisations that brought together dispersed sources of saving into pools of assets that were invested in activities promising a higher rate of return than that otherwise available at home. But few banks have been able to hold their own in the global investment management industry. On this issue, we make two specific claims.

First, there is a dominant model of investment management which, if not hegemonic, is the reference point for the organisation of the investment management industry (see, Arjaliès et al., 2017; Clark and Monk, 2017). This model of management is centred on asset classes (e.g., bonds, equities, property and infrastructure), relies upon teams of investment professionals headed by acknowledged specialists and is subject to performance criteria that are less about cost efficiency and more about meeting investment targets against third-party indices and benchmarks. Second, risk and uncertainty dominate the investment process but is ‘managed’ in the sense that successful investment managers are those that have some advantage in this domain over competitors.

The investment management process is, of course, informed by information on market movements, the anticipated actions of other investors, and theories of investment and market performance amongst other issues that are more-or-less contested inside and outside of the industry (Scheinkman, 2014). In this respect, an important issue is determining what type of organisation is better able to manage the investment process such that the interests of investment professionals, their employers and clients are realised through predictable and superior rates of return. This issue is not settled. Rather, there is competition between types of organisations for financial market share and dominance.

In some countries, large retail banks have significant investment management groups (e.g., Canada). In some countries, industrial conglomerates have developed their own investment management groups rivalling, in some cases, the engineering and manufacturing activities of the same company (e.g., General Electric). In those countries with large stock markets (measured against GDP), there is an extensive ecosystem of small, medium and large investment companies serviced by a myriad of specialist providers (Clark, 2016). Although the largest investment companies dominate these markets (e.g., BlackRock, Fidelity and Vanguard in the United Statets), there is a market for small and medium-sized investment companies that offer distinctive investment philosophies and processes (e.g., Latitude LLC and Rathbones in the UK).

New types of investment products, different ways of managing the investment process, and technology-related developments underpinning the investment process tend to flow from the largest markets (London and NYC) to smaller markets (e.g., Europe) and from Silicon Valley to London and NYC and on to other markets. Most importantly, new initiatives in investment management which begin at the margins of large markets are often acquired by larger investment companies seeking access to winning modes of organisation and management (process-related, product-related and/or technology-related) not otherwise available to those companies. In this respect, the largest investment groups often maintain competing investment teams in either a Darwinian fight for survival or an uneasy truce via coexistence.

Scale and scope tend to reinforce the position of the largest investment groups (Fichtner et al., 2017). Even so, the largest groups face various threats: being slow to respond to market innovation, over-committing to teams and investment philosophies that are stale, and consistently under-performing competitors on a cost-based measure of value-added. This can lead to the loss of clients, stagnating shares of total assets under management and reputational damage. Given the importance of financial performance, lagging behind the market can be organisationally and professionally costly. Not surprisingly, the biggest companies often acquire the so-called proven ‘start-ups’ to leap-frog inertia, as exemplified in the case of TruCost.

Financial innovation: ESG and truCost ⁹

In 2000, the UK Chancellor of the Exchequer initiated an inquiry into ‘distortions’ in the institutional investment process. Considering the competence and integrity of both sides of the market (asset managers and asset owners), the resulting Myners Review found that asset owners often lacked the resources and expertise to be effective investors just as the behaviour of, and incentives of, asset managers often resulted in significant shortfalls in investment performance. Traded companies were deemed unaccountable to owners and investment managers were deemed self-interested at the expense of clients (Myners, 2001).

In this vein, Monks (2001), a US corporate governance activist, published a series of books arguing that the global investment industry prized profit over responsibility thereby discounting, in large part, corporate accountability. Monks was an establishment figure, a member of the Republican Party and an advisor to the US federal government during the Reagan era. In the UK, he raised concerns about the performance of the UK investment industry and the need to hold corporations to account for their societal impacts (see Monks and Sykes, 2002 and Blake 2003). This argument was joined by Paul Myners, a leading investment advisor, closely linked with the UK Chancellor (Treasurer) and the Labour Government (he was later knighted for services to UK corporate governance).

Myners and Monks promoted a critical assessment of the finance industry and major corporations without ever addressing Milton Friedman's aphorism. Capitalism was not in doubt. At issue was the behaviour of investors and corporate executives. Workshops were held in major universities on both sides of the Atlantic bringing together industry critics, academics and activists seeking to make a long-term impact on both sides of the market. ¹⁰ In the aftermath of the global financial crisis, the Kay Review (2012) on the performance of the finance industry sharpened the critique by identifying systematic failures in the governance and management of the industry (see also, Clark, 2013).

We illustrate the significance of these initiatives through a case study of TruCost. This company is an instance of innovation that crystallised the emerging market for environmental and social measures and metrics of corporate performance. This company is iconic, arguably, in the sense that its establishment and success have been a benchmark against which other related initiatives in the Anglo-American finance industry have been judged. TruCost's success has also demonstrated that there was a viable market for such an initiative, well before ESG became fashionable, along with the prospects of further growth and development. As noted below, it was successful on a variety of levels. It developed innovative methods and measures that were then replicated in the industry. Its success in London became a success in New York when it was acquired by S&P, a major data provider at the centre of the world's largest financial markets.

TruCost was established in London in 2000 with the help of Monks. Its founders were UK entrepreneurs who believed that companies would be increasingly required to provide information on their environmental footprints in ways amenable to comparison and investment. Consulting companies had established practices to provide companies with information on their environmental footprints for the purposes of cost reduction, management and reporting. This type of data was often confidential to the consulting companies and their clients. The founders of TruCost also believed that companies would be required to disclose this type of information to the market using third-party metrics that could be relied upon for their veracity and comparability over time.

There was arguably a sense of shared purpose binding the partners, employees and investors to the project, as ‘close dialogue’ with these groups attested. This was expressed on two sides of the market for corporate control. On one side, the company sought to inform analysts about the value of listed companies considering their environmental footprints, risks and performance. In this manner, TruCost focused on the E (environment) of the burgeoning ESG field. On the other side of the market, the company sought to improve the management of corporations’ environmental footprints through metrics appropriate to those businesses and industries. Their involvement with Puma (a footwear company) focused upon developing an environmental profit and loss statement to aid internal decision-making. This case study was widely cited in the industry and beyond. ¹¹

Competitors began to offer similar types of data and products, some of which were focused on the carbon and environmental footprints of corporations whereas others had a broader reach including social and governance factors. The S and the G had been, and remain to some extent, important elements in the market for corporate social responsibility (Clark and Hebb, 2005). So, for example, the apartheid disinvestment campaign was led from London and was able to influence the investment industry and ultimately the UK government on these matters. Crucially, the founders of TruCost believed that carbon footprinting was less about social responsibility and more about corporate performance and value over the long term. They believed that the market for metrics would grow rapidly over the coming 10 years.

Over the period 2006–2016, TruCost advertised a variety of services. First, TruCost could provide an inventory of corporates’ environmental footprints covering the FTSE100 and the S&P500. Second, it could provide verifiable third-party data and information going beyond the data disclosed by companies. As such, TruCost was able to provide checks on company-disclosed environmental data and reports. Third, it had the data and metrics sufficient to translate corporate environmental performance into financial risk and return, or at least what can be approximated as such. In effect, their environmental data and metrics combined depth and breadth set within electronic retrieval systems that were readily searched for insight about value. If rudimentary by present standards, one of the selling points was its electronic architecture. Here, we are not making a point about the effectiveness or reliability of TruCost's data and information systems in terms of measuring environmental risks and performance. With regards to legitimacy, it is the appearance of sophistication and sufficiency coupled with placement and use by the right actors and places that matters (see also Arjaliès, 2010). ¹²

By 2016, the company employed approximately 110 people, concentrated in London but with offshore processing facilities. The market for its products and services had grown and spread to Asia, Australia, North America and beyond. Furthermore, the company adapted its products and services as the market diversified in terms of relevant issues, such as supply chains. For the financial information and analytics firm S&P Global, reliant upon TruCost for data and expertise in ESG, another buyer of the company would have represented a challenge to its US market position on these issues. At base, TruCost provided conceivably hard to replicate data, relevant products in the ESG space and expertise not otherwise available within S&P.

Since S&P's purchase of the company, it has grown rapidly in employment, revenue, the range and nature of products and its geographical reach. S&P provided the resources to expand as well as the capacity to create complementary products vis-à-vis other activities of the parent company. ¹³ As for the current headcount, it is more than 200 people – given its integration in the larger S&P environment, its activities have broadened such that its value-added is likely far higher than that represented by the headcount. For example, its measures and metrics are now incorporated into various market indices and related products that track market expectations at S&P.

Three factors have accelerated its growth. First, its ESG products have been incorporated into mainstream market factors and variables. Second, rather than simply looking back and extrapolating forward, the E factor in ESG has become important for investors seeking to track corporate responses to climate change. Third, whereas the S and the G have had historical significance, the E factor has been amenable to measures and metrics that allow for monitoring and direct comparison between companies and between sectors. As such, the growth on the E side has been driven by the fact that it is measurable and comparable.

Since acquiring the company, S&P has acquired other related companies and has relied upon executives from the original company to play a role in acquiring smaller ESG metrics companies into the fold. Because S&P is a diverse, multi-line business it has proven that it can accommodate different types of companies with different metrics and measures without forcing convergence upon one model or one method of measurement, which arguably adds scope to S&P's offer to users in judging corporate performance including systematic differences between industries in their environmental exposure.

Legitimacy – crafted through metrics

The emergence of ESG and its recent embrace by the global asset management industry is in no small part the result of apparent shortcomings in the integrity and practices of the global investment management industry (Morris and Vines, 2014). Flaws at the heart of liberal democracies have prompted governments to act incrementally rather than strategically in favour of future generations (Cohen, 2009; Estlund, 2008). Climate change has brought these flaws into the open, highlighting the reluctance of governments to regulate corporations’ and investors’ carbon footprints and restructure their businesses accordingly. In the main, western governments have deflected responsibility for acting on behalf of future generations to private investors. ¹⁴

It was observed in the previous section that the global investment management industry was accused 20 years ago of being absent or benign owners. This accusation was, in a sense, misplaced – if they were absent or benign owners, their lack of engagement was on behalf of clients who were similarly ‘asleep at the wheel’. Well-placed critics sought to enhance the engagement of asset managers on behalf of asset owners such that the quality of corporate governance was improved and responsive to key issues of the day.

By contrast, 40 years ago asset managers and the finance industry more generally were deemed culpable for successive waves of restructuring in European and North American manufacturing industries (Bluestone and Harrison, 1982). Being disengaged from corporate America, the finance industry could pick and choose its targets and stand-apart from the real economy in favour of the development of financial instruments and products that treated the objects of investment – industries and companies – as the building blocks of investment portfolios. The challenge posed to the investment management industry by Monks and Myners and those that followed in their wake was to enhance the quality of corporate governance by referencing standards of best practice that governments on both sides of the Atlantic could agree with. Given the theory and practice of modern investment management, it was easy enough for major investment companies to embrace these issues.

As the industry embraced portfolio investment and as the mantra of ‘good governance’ came to dominate the assessment of corporate performance, the finance industry was able to pick and choose winners over losers by reference to rudimentary measures of governance that were used to justify investment decision-making (Hawley and Williams, 2005). In large part, codes of practice were voluntary rather than mandatory and industry-based rather than set by regulatory agencies with appropriate standards of compliance. TruCost took advantage of these developments by making an equivalence – rhetorically and in fact – between good governance and corporate environmental performance. If a sleight of hand rather than the demonstrable fact, it served to legitimate the link between corporate governance and environmental performance.

Nonetheless, advocates of good governance have faced two challenges. In the first instance, there has been considerable debate as to what counts as ‘good’ governance. For example, corporate boards with a large minority of independent directors are oftentimes invoked as representing best practice just as, more recently, having a diverse board (by gender, race and ethnicity) is believed to make a difference to board deliberations (e.g., Naciti, 2019). There is significant and growing academic literature on these topics amongst others. In the second instance, however, it is challenging to show cause and effect. That is, whether the nature and composition of a board of directors make a difference to corporate financial performance in the short term and, most importantly, in the long term. Few scholars doubt that there is a connection. However, calibrating cause-and-effect has proven to be very challenging.

By contrast, companies like TruCost who entered the global market for financial services through the auspices of good governance had an easier task in explaining their added value notwithstanding widespread indifference to the issue of the environment in principle and in practice. For those corporations reliant upon the environment in making products and distributing those products to the world at large, there was an existing market for environmental performance served by consulting companies. Companies like TruCost offered a broader range of metrics, standardised measures of performance, and a platform through which to compare performance company by company and jurisdiction by jurisdiction.

If challenging to measure, environmental inputs and outputs had, and continue to have, tangible effects on corporate costs of production and their short-term and long-term liabilities. To the extent that reported profits are directly influenced by the costs of production, investors began to focus on these types of issues (in the short term) and pay attention to environmental liabilities (in the long term). In this regards, TruCost offered third-party metrics with estimates or measures of environmental performance that were directly comparable within industries and across industries. Furthermore, as regulatory agencies became attuned to the long-term environmental costs of certain types of industries (e.g., asbestos, chemicals, pharmaceuticals and the like) companies and investment managers sought to better understand corporate environmental footprints.

As climate change has become more important in the public consciousness and for governments (as evident in the proceedings of COP21 and COP26), multifactor measures of corporate environmental performance have given way to carbon footprinting. Again, this type of measure along with its associated metrics is important for corporate management for investment companies seeking to align themselves with peer-based organisations such as the Principles of Responsible Investing (PRI). Here, there is a premium on breadth and depth in third-party measures and metrics such that it is sufficient to contract with one or possibly two data providers rather than a myriad of providers that have limited exposure to certain types of companies and industries, jurisdictions as well as carbon and/or environmental factors.

A group of four or five global firms (e.g., MSCI, Refinitiv, S&P Global, Bloomberg, Sustainalytics) have emerged from the many start-ups that provided specialised measures and metrics by jurisdiction and the like. A global market for carbon measures and metrics has developed in ways consistent with the interests of the investment management industry in covering major market indices and the universe of traded securities. At the limit, this involves 4000–5000 stocks. Here, investment companies and their clients are focused on three issues. First, corporate metrics can be linked to global climate change. Second, measures and metrics that account for carbon density of a firm and its industry considering the full spectrum of corporate activities. Third, measures and metrics can be repeated time and again to provide investment groups with an ability to predict near-term and long-term corporate carbon exposure.

Underpinning these developments are certain suppositions or expectations. On one hand, it is often assumed that a global market for carbon will emerge whether sponsored by existing financial markets and/or governments or both. On the other hand, absent the establishment of carbon markets by country and region, it is assumed that there will be a shadow market for carbon however inefficient and/or partial in coverage. This type of market is likely to set a global carbon price which investors are likely to reference when making forward commitments in terms of staying with a set of companies and/or industries that can navigate the global economy 5, 10 and 25 years out. If there are region-specific carbon prices, market heterogeneity is likely to be an arbitrary opportunity for investors with inside knowledge and funding to take advantage of mispricing.

In these ways, the global investment management industry has willingly embraced carbon prices even if steps in that direction have been partial and relatively slow (against the carbon emergency). Notice, these developments have occurred absent direct government intervention. Indeed, although some of the world's largest emitters again made carbon reduction commitments at the COP26 meeting in Glasgow, a new global framework for carbon pricing and trading was not in the offing, nor was progress made at COP27 in Sharm El Sheikh. Nonetheless, the legitimacy of finance is being underwritten by the many steps taken to create carbon pricing through industry innovation and competition.

Implications and conclusions

Although many governments highlight the importance of climate change, few have taken steps to allocate the costs of climate change to public and private actors. Academics and scientists despair about the evident reluctance of western governments to institute, for example, carbon pricing and trading regimes (Hepburn et al., 2020). ¹⁵ Nonetheless, Anglo-American governments have provided, often by default, the global financial services industry with a permissive or ‘soft’ regulatory environment to lead on these issues. If not obviously about the implementation of climate-related commitments through to 2050, the finance industry has been ‘permitted’ to innovate on ESG issues over the past 20 years or so. The finance industry has grasped this opportunity with élan – it has also faced significant challenges to its legitimacy.

Innovation in this area has seen the development of ESG measures and metrics for corporate valuation and financial arbitrage. Twenty years ago, as the first steps were taken in developing relevant products and markets, these initiatives were allied with conventional arguments in favour of ‘good’ corporate governance. In academic and policy circles, there was widespread concern about the lack of accountability of senior corporate executives to shareholders and stakeholders (see Jensen, 2000). Whereas the market for corporate governance emphasised the ‘G’ over ‘S’ and ‘E’, an explicit link was made between the first and the third component, suggesting that environmental matters deserved closer scrutiny.

London-based financial markets and organisations were congenial hosts to these developments. Here, a case study of TruCost (now owned by S&P) was used to chart the development of these initiatives including reference to the evolving market for ESG measures and metrics as well as the ways in which these types of companies developed products applicable to FTSE100 firms and beyond. Success was found in building comprehensive databases that allowed for direct comparison between companies and industries on environment-related aspects of production. With other start-ups, TruCost ‘made’ the market for environmental measures and metrics.

None of these companies faced government regulations or requirements as to the nature, composition and scope of these measures and metrics. As the market developed, the businesses of start-ups like TruCost evolved from being reliant upon projects and interventions on these issues to offering comprehensive datasets allowing for the integration of ESG into financial trading and valuation. Here, again, financial regulators relied (by default) upon the market for financial innovation to ‘discover’ what worked, what did not work and the nature and scope of the value-added offered by different start-ups. Twenty years later, with a newly elected US president, the US Securities and Exchange Commission announced an ‘interest’ in the nature and scope of the ESG measures and metrics business.

At another level, however, ESG measures and metrics will not be sufficient for private actors to realise our collective interest in holding global warming to +2°C by 2050. Even so, the ESG movement has mobilised the global investment management industry to take these issues seriously if only to serve the burgeoning interests of asset owners in these issues. Whether cause or effect, the success of ESG measures and metrics has allowed asset owners to join with asset managers in integrating these factors into investment portfolios. Asset owners have reinforced the value of ESG measures and metrics thereby broadening and deepening the market for these factors.

With climate change on the investment agenda, recent developments suggest that the global investment industry will also reap returns through the restructuring of companies and industries in the face of accelerating demands on these organisations to play their role in realising long-term climate objectives. As investment owners and managers have faced significant challenges in realising their goals in public markets, moves have been made to invest in private equity, venture capital and financial vehicles that will leverage and restructure the past in favour of carbon neutrality in the future. In this respect, these types of investors seek a premium on corporate restructuring analogous to that realised through the 1980s and 1990s.

As a result, ESG measures and metrics are increasingly at the core of the investment process, framing and justifying corporate restructuring by reference to COP-related targets. The ESG movement has done more than mobilise the investment management industry in favour of eco-efficiency. It has also carried a generation of investors into the opportunities for higher returns on corporate restructuring in favour of 2050 goals and objectives. As such, the ESG movement presaged the advent of an emerging era of carbon-neutral corporate capitalism and/or climate change capitalism. If seemingly grandiose, this claim should not be taken as evidence of expected material outcomes. Carbon-neutral corporate capitalism and climate change capitalism are simply shorthand to capture the palpable shift in concern for climate change amongst investors and corporations. To be sure, ESG will remain contested and challenged by those that see it as destroying value for shareholders, while others will continue to claim ESG is simply greenwashing. Notwithstanding, climate change as an investment thesis has taken hold.

The challenge for liberal democracies will be to enhance the success of the movement already begun without being held hostage to the political costs of restructuring. Governments may well be asked to pay the price for carbon-neutral corporate capitalism in terms of industries transformed, jobs lost and whole communities turned upside down. The challenge will be to deal with these issues without being stymied by those adversely affected by the new era of carbon-neutral corporate restructuring. Realising ambitious goals for 2050 will depend upon governments building political coalitions that share or in some sense ameliorate the costs and benefits of climate change–related restructuring over the long term. Whether liberal democracies are up for the challenge remains to be seen. As it is, the Anglo-American asset management industry is betting on realising a premium on the path to 2050.