Managers of ESG funds have once again been caught in the middle of a market catastrophe.
Shares of Adani Green Energy Ltd., which are held by roughly 770 ESG funds globally, recently saw a 25% decline in value following US authorities’ charges of alleged bribery against Gautam Adani. It’s one of several Adani empire companies that passed ESG scrutiny only to have investors ditch them as they process another long list of purported violations.
“Adani Green’s terrible governance was in plain view,” said Henry Kinnersley, co-founder of short seller Snowcap Research.
Federal prosecutors in the US have accused Adani and several associates of promising more than $250 million in bribes to Indian government officials in exchange for solar energy contracts for Adani Green. This comes nearly two years after a report by another short seller, Hindenburg Research, accused the Adani Group of decades of fraud and market manipulation.
The Adani Group has refuted the claims. However, as investors processed the information, the Adani Group’s total market value dropped by almost $27 billion as a result of the US indictment.
According to EU laws, the majority of funds that own Adani Green are promoted as either “promoting” environmental, social, and good governance measures or making ESG an explicit “objective.”
About $400 billion is managed by the 770 funds collectively, some of which are run by the biggest asset managers in the world. Adani Green’s holdings typically account for less than 1% of the net asset value of the funds.
ESG fund managers typically charge higher fees because they are expected to implement more safeguards to shield investors from environmental, social, and governance risks. However, the label has consistently fallen short in practice.
According to earlier reports, ESG funds had Russian assets at the time of Vladimir Putin’s invasion of Ukraine. These investments included state oil and gas firms as well as government bonds. After failing to respond to growing governance risks, Silicon Valley Bank’s abrupt collapse early last year also caught ESG funds off guard.
According to Mohit Mirpuri, a portfolio manager at SGMC Capital Pte., who sold his exposure to Adani Green’s bonds in late 2022 because he was worried the firm was depending too heavily on leverage, it is “surprising” that hundreds of ESG funds are still invested in the company.
“There’s no case to be made to hold shares right now,” and the continued presence of ESG funds in the company “calls into question” their ability to properly screen for governance risks, he said.
Investors who have shunned ESG for a long time are taking advantage of this to attack the sector’s alleged shortcomings.
The Adani Green case, according to Barry Norris, founder and chief investment officer of the UK hedge fund Argonaut Capital Partners, demonstrates how the ESG movement can accommodate “malfeasance, chicanery, and skullduggery” while operating “under the cloak of morality.”
The way index providers conduct due diligence when assigning the ESG ratings that decide a company’s eligibility for inclusion in exchange-traded funds and other passive strategies has also drawn criticism. According to Bloomberg data, there are over 70 ETFs that track ESG standards and include Adani Green.
The Securities and Exchange Commission claimed in its complaint that Adani Green lured investors to a 2021 bond issue by using its “A” grade from MSCI Inc.’s ESG research unit.
About six months after the Hindenburg report, in July 2023, MSCI downgraded Adani Green to “BBB.” A spokeswoman told Bloomberg that the company is currently “closely reviewing” the most recent developments in the Adani case. According to the spokeswoman, MSCI raises concerns about alleged fraud and commercial ethics, including bribery.
Adani Green has a Risk Score of 14.3 from Morningstar Sustainalytics, which rates companies from 0 to 100, with 100 being the lowest possible score. Additionally, it gives the business a “low” Risk Category rating.
The rating “is primarily driven by the company’s negligible risks related to material environmental and social issues, including human capital, occupational health and safety, land use and biodiversity, as well as product governance,” Hortense Bioy, global head of sustainability research at Morningstar Sustainalytics, said in an emailed response to questions.
Additionally, Bioy stated that the corporation’s corporate governance, which makes up 31% of all ESG concerns judged “material for the company,” has been given a “medium” Risk Score. Additionally, Adani Green has “been flagged as having a significant level of controversy, with a weak political involvement policy and a weak business ethics program.”
According to Bioy, Morningstar Sustainalytics’ report “will be reviewed in light of recent events,” and the company is currently facing “increasing financial, regulatory, and reputational risks stemming from new evidence and investigations into its allegedly fraudulent business practices.”
With an aim of 50 gigawatts of renewable energy by 2030, or about 10% of India’s targets, Adani Green has been in the forefront of the country’s transition to renewable energy. Furthermore, Prime Minister Narendra Modi has a close ties with Gautam Adani, the second-richest man in Asia, which has helped his vast business empire.
According to Transparency International’s Corruption Perceptions Index, India is ranked 93rd out of 180 nations, and most investors anticipate worse governance or legal structures in emerging markets. However, according to the SEC, Adani Green has “positioned itself as a leader in environmentally conscious, socially responsible, and good corporate governance principles.”
“The dichotomy of ESG is that many investors chose to ignore” the red flags surrounding Adani Green because it was operating in the sustainable sector, Snowcap’s Kinnersley said.
The US indictment “dispels the notion that governance can be assessed relative to local norms in a foreign market,” he said. “Any company raising capital from US investors should clearly expect to be held to US standards.”
