Hindenburg row: Adani shock rips through ESG funds as strategy fails test

Stocks bearing the Adani name appear in over 500 so-called Article 8 funds that are supposed to “promote” ESG goals, provided that the companies in which the investments are made follow good governance practices under European Union rules, according to data compiled by Bloomberg.

As many as 80 of those exposures are through direct holdings, while the remaining are mostly through funds of funds or index trackers, the data shows, which correct for duplicate holdings.

As the Adani Group companies get stripped from indexes and are put under review amid allegations of improper use of offshore tax havens and stock 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.

What are ESG funds

ESG funds are investments which make investment commitment based on environmental, social, and governance factors. A firm that makes investments in an ESG fund should be well-run and also have a positive impact on the environment and society as well.

Also, ESG funds seeks to benefit society and the environment while also producing financial returns.

ESG analysts believe that the strong headwinds faced by the Adani Group could impact access to offshore ESG-linked financing plans of other Indian firms.

An individual who tracks ESG investments has termed the Adani crisis as a bad omen for India’s green energy ambitions.

In the wake of a late January report by US-based short seller Hindenburg Research, the selloff in the Adani Group’s seven listed subsidiaries have cumulatively lost about $120 billion in group market value in the last three weeks.

Funds with nearly $10 billion in assets under management tracking MSCI ESG indexes held shares in Adani Enterprises Ltd alone, as per an analysis by the Anthropocene Fixed Income Institute. The institute has been studying the Adani Group since mid-2020.

In a report on Adani published on 9 February, Ulf Erlandsson, AFII’s chief executive officer, and Stephanie Mielnik, its head of fixed-income research, wrote: “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.”

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 was quoted as saying by Bloomberg.

27% of Article 8 funds meet its sustainability requirement

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 denied all allegations, calling them “malicious”, “baseless” and a “calculated attack on India”. It called Hindenburg the “Madoffs of Manhattan”, referring to the late financier and fraudster Bernie Madoff.

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.

Asia ESG funds global market share doubles

Meanwhile, in Asia, ESG funds have doubled their international market share as political and regulatory upheavals slow inflows for environmental, social and governance investing in the US and Europe.

Barclays Plc analysts including Dave Dai wrote in a note that Asia funds posted net inflows of 15% last year, as against 4% globally. That doubled Asia’s ESG fund market share to 4%, from 2% at the end of 2020, Barclays noted.

Asia’s net inflows into ESG stock and bond funds compared with 5% for non-ESG funds in the region, showing “stronger investor appetite for sustainable investing,” the analysts further said.

With agency inputs