ESG Trends Create Massive Arbitrage Opportunity – Dividend.com

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ESG Trends Create Massive Arbitrage Opportunities – Dividend.com

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Public investors are increasingly interested in ESG (environmental, social, governance) as a way to make their portfolios more sustainable. BlackRock CEO Larry Fink warned that private capital must be included in the journey to net zero or we risk the “biggest capital arbitrage of our lifetime” if fossil fuel companies are allowed to fall into private hands.
Let’s take a look at ESG investing in public markets and the possibility of hydrocarbon assets falling into bad hands.
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At the end of the third quarter, global sustainable mutual fund assets reached a record $4 trillion. Morningstar reports that the global sustainable universe grew by more than 51% to 7,486 mutual funds in the third quarter. The majority of the growth was due to Europe’s new disclosure rules for ESG investment criteria.

Inflows to thematic funds in Q3 2021 were most concentrated in the energy transition. Source: MSCI
Europe’s Sustainable Finance Disclosure Regulations (SFDR) set specific rules for how and what sustainability-related information financial market participants and advisors must disclose. This is done to prevent the ‘greenwashing of financial products and advice in order to help investors achieve their sustainable investment goals.
SEC Acting Chair Allison Herren Lee directed Division of Corporate Finance in February 2021 to increase its focus on climate-related disclosures in public company filings. The agency plans to update its 2010 guidance to reflect developments in the past decade and improve climate disclosures in America.
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Given the large capital inflow to ESG funds, public companies are being pressured to sell their fossil fuel assets. BP (BP), Chevron(CVX), Shell, (RDS-B), ExxonMobil [XOM], Eni (E), Equinor (“EQNR”) and other fossil fuel projects have been sold to private companies for more than $100 billion this year. As disclosure rules are implemented, many of these assets are being offered for sale at fire-sale.

Big oil continues to buy hydrocarbon assets. Source: FT
Larry Fink, BlackRock Chairman and CEO, points out that the transition to private companies is difficult because hydrocarbon assets are shifting from transparent public to opaque private businesses. These private companies are less likely to be scrutinized for their activities and can squeeze as much production as they want without disclosing any environmental consequences.
Many of these private companies could also make a fortune off investor enthusiasm for ESG trends. ESG-compliant assets are becoming more expensive as oil majors sell at fire-sale price, while private companies are buying up fossil fuel projects at a steep discount. This is a huge arbitrage that could prove to be counterproductive.

ESG investments have been growing in popularity over the past few years. Many fossil fuel companies are selling hydrocarbon projects to private companies, which face less regulatory scrutiny, as regulators increase disclosure requirements. These companies may have a greater impact on the environment than those that make more environmental disclosures.
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