Today's edition of the New York Times featured an opinion piece that critiqued ESG investing--and not from the perspective that "values" investing is economically counter-productive. (For that viewpoint, the editorial page of the Wall Street Journal typically provides a platform. ( Rather, this article criticized ESG investing on the basis that investments that are currently labeled as ESG-compliant do not in fact conform with ESG principles.

Specifically, the article opined that companies are considered ESG-friendly not based "on their degree of environment or social responsibility," but rather on "how much potential harm E.S.G. factors like carbon emissions have on companies' financial performance." In other words, this critique focused on the notion that an ESG-compliant investment should focus on corporate social responsibility, rather than the economic risks companies face due to the energy transition as a result of climate change.

Fundamentally, the article criticizes the current system of ESG ratings, and argues that instead of "measuring the risks that environmental and social developments pose to companies, raters and investors should measure the risks to humanity posed by companies." In particular, the author advocates that "rating agencies [should] measure the costs to society and the environment that are not directly borne by companies--what economists call negative externalities. This would include the health care costs to society of smoking or excessive soda consumption or the acceleration of climate change as a result of greenhouse gas emissions." Such a system would be a significant deviation from the various ratings currently provided by the rating agencies.

This criticism--although it goes considerably further--echoes recent statements and enforcement actions from the SEC, which are concerned about the phenomenon of "greenwashing." It seems likely that this public and regulatory pressure will likely influence investment funds to be more deliberate in crafting ESG-compliant investment vehicles, and possibly to adapt a more rigorous approach to the selection criteria for investments that would be considered proper for ESG-focused investing.

Perhaps the biggest problem is the ratings industry. To construct E.S.G. funds, investment managers rely on rating agencies — such as Sustainalytics, S&P and MSCI — that create indexes grouping sets of companies that are meant to be good corporate citizens. (Some examples are the Dow Jones Sustainability World Index and the MSCI ESG Universal Indexes.) These agencies also rate companies on E.S.G. criteria and sell the ratings to investment firms.

But contrary to the spirit of E.S.G. investing (and likely unknown to most investors), the leading rating agencies are not scoring companies on their degree of environmental or social responsibility. Instead, they are measuring how much potential harm E.S.G. factors like carbon emissions have on companies’ financial performance.