ESG Vigilantes

The market tends to avoid or ignore risk until faced with abrupt crisis: a lost lawsuit, legal challenge, government action, or act of violence.  Corporations have generally been unwilling to alter practices without government intervention.  One example that comes to mind is the necessity of government involvement to ban investments in Cuba, North Korea, and Iran.

The sudden incorporation of ESG risks into stock prices implies a long-term bimodal model of returns.  In the short-term, one might expect increased volatility prior to crisis, as investors assess the perceived risk of “ESG-unfriendly” companies through risk-on and risk-off trades.  However, there is no fundamental shift in value until actual crisis.

Is it plausible to conclude that, as ESG factors gain in relevance, the market rather than the government will be the driving force to instigate change?  A small body of consumers and investors penalize companies that fail to adhere to high environmental, social, and governance standards.  I remain skeptical as to whether this ensemble will ever grow large enough to be truly impactful, but the idea is not completely unreasonable.

Bond vigilantes have become a credible force in the bond market by forcing rates higher in inflationary environments, prior to Federal Reserve action.  In some circumstances, the bond vigilantes have been so successful that government action has not been required.

Is it possible ESG vigilantes will emerge, forcing company action by affecting stock prices prior to government intervention, such that intervention no longer becomes necessary?

8 thoughts on “ESG Vigilantes

  1. Interesting analogy. Usually the market seems to anticipate events. Often stocks rise and when the good news appears, stock prices drop or stay flat, as investors have already incorporated the events into their valuations well before. Seems as if the bond vigilantes appear in times of stress. Quite possible, with the imminent threats such as global warming, that the ESG vigilantes (Is that an original term? nice work! ) may actually precede government action and precipitate changes by corporations well before regulation. Discipline from the market would be a welcome solution to some of the ESG issues of the day!

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  2. Seems to me that the market (i.e. investors) are the game players, and that governments/regulatory bodies (hopefully a reflection of the public–which includes investors and non-investors alike) are the referees. If the refs, influenced by investors but also non-investors, make ESG-related rules that are clearly understood (i.e. a transparent price on carbon), then the game players will adjust, as will the corporations they invest in. So far, the results on having clear, meaningful ESG-related rules, are not good but the game isn’t over.

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    • The major impediment is that in order for the “refs” (i.e. Government) to be influenced by the “game players”, (i.e. the market), the game players need to be vast in number. Currently, there exists only a small ensemble of consumers and investors who make buying decisions with ESG as first priority.

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