(Bloomberg) -- ESG fund managers have once again found themselves on the wrong side of a market meltdown.
Roughly 770 ESG funds worldwide hold shares of Adani Green Energy Ltd., which just lost about a quarter of its value after US prosecutors charged Gautam Adani with suspected bribery. It’s one of a group of companies in the Adani empire that made it past ESG screens, only to be dumped by investors as they digest a fresh litany of alleged breaches.
“Adani Green’s terrible governance was in plain view,” said Henry Kinnersley, co-founder of shortseller Snowcap Research.
Almost two years after a report by another short seller, Hindenburg Research, accused the Adani Group of decades of fraud and market manipulation, federal prosecutors in the US have alleged that Adani and a number of people around him promised more than $250 million in bribes to Indian government officials in exchange for solar energy contracts for Adani Green.
The Adani Group has denied the allegations. But news of the US indictment wiped about $27 billion off the Adani Group’s combined market value as investors digest the details.
Most of the funds holding Adani Green are marketed as either “promoting” environmental, social and good governance metrics, or making ESG an outright “objective,” which are categories enshrined in European Union regulations.
Together, the 770 funds oversee about $400 billion and some of them are managed by the world’s largest asset managers. On average, the holdings of Adani Green make up less than 1% of the funds’ net asset value.
ESG fund managers are supposed to apply extra screens to protect investment clients from environmental, social and governance risks, something for which they often charge higher fees. But in practice, the label has repeatedly failed to deliver.
Bloomberg has previously reported that ESG funds were holders of Russian assets as Vladimir Putin invaded Ukraine. Those holdings extended to government bonds and state oil and gas companies. ESG funds were also wrong-footed by the sudden collapse of Silicon Valley Bank early last year, after failing to react to mounting governance risks.
The fact that hundreds of ESG funds are still exposed to Adani Green is “surprising,” according to Mohit Mirpuri, a portfolio manager at SGMC Capital Pte. who says he sold his exposure to the company’s bonds in late 2022, due to concerns the company was relying too much on leverage.
“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 long avoided ESG are using this as a moment to rip into the industry’s apparent failings.
Barry Norris, founder and chief investment officer of UK hedge fund Argonaut Capital Partners, said the Adani Green example shows that the ESG movement is perfectly capable of housing “malfeasance, chicanery and skullduggery,” and doing so “under the cloak of morality.”
Index providers also have faced some heat over their approach to due diligence when handing out the ESG ratings that determine how readily a company is included in exchange-traded funds and other passive strategies. There are about 70 ETFs tracking ESG benchmarks that hold Adani Green, Bloomberg data show.
In its complaint, the Securities and Exchange Commission said Adani Green used its “A” rating from the ESG research unit of MSCI Inc. to attract investors to a 2021 bond sale.
MSCI downgraded Adani Green to “BBB” in July 2023, about six months after the Hindenburg report. The firm is now “closely reviewing” the latest developments in the Adani case, a spokesperson told Bloomberg. MSCI flags business ethics and fraud allegations, including bribery, the spokesperson said.
Morningstar Sustainalytics gives Adani Green a Risk Score of 14.3 on a scale of zero to 100, where 100 is the worst rating. It also assigns the company a so-called Risk Category of “low.”
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.
Bioy also noted that the company has been assigned a “medium” Risk Score for its corporate governance, which accounts for 31% of the overall ESG issues deemed “material for the company,” she said. And Adani Green has “been flagged as having a significant level of controversy, with a weak business ethics program and a weak political involvement policy.”
The company now faces “increasing financial, regulatory, and reputational risks stemming from new evidence and investigations into its allegedly fraudulent business practices,” Bioy said, and Morningstar Sustainalytics’ analysis “will be reviewed in light of recent events.”
Adani Green has been at the heart of India’s shift to renewable energy, with the company’s target of producing 50 gigawatts of renewable energy by 2030 equivalent to roughly 10% of India’s goals. And Gautam Adani, Asia’s second-richest man, is a close ally of Prime Minister Narendra Modi, a relationship that has benefited his sprawling business empire.
Most investors expect weaker governance or legal structures when it comes to emerging markets, and India ranks 93 out of 180 countries in the Corruption Perceptions Index of Transparency International. But Adani Green has “positioned itself as a leader in environmentally conscious, socially responsible, and good corporate governance principles,” the SEC said.
“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.”
--With assistance from Amine Haddaoui.
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