Building sustainable businesses is the central challenge of our time, but nobody said it would be easy. The business world currently sees sustainability as being consistent with business needs. Paying workers more will see higher sales and productivity that will eventually pay for themselves, while cutting emissions also cuts down energy costs, thus benefiting bottom lines.

Yet Rob Almeida, global investment strategist at MFS Investment Management, and his colleague, research analyst Robert Wilson, see such arguments as magical thinking. “Sustainability isn’t free, and in our view, efforts to become more sustainable will challenge many companies and perhaps even bankrupt some of them,” they warn investors.

Not that the duo are climate change deniers who would bury their heads in the sand while the world burns. They acknowledge that ESG is key to the long-term success of the global community. Should unsustainable practices such as “runaway climate change” or rising income inequality persist, the outcome for humanity as a collective is seen to be profoundly negative.

But perhaps what businesses are afraid of admitting, Almeida and Wilson argue, is that the market-wise shift towards sustainable business practices is a form of disruption “akin to the industrial revolution or the advent of the internet”. Such a change will see winners and losers, with some firms having to pay the cost of this move towards more sustainable practices. Current narratives, they believe, must take greater account of sustainability’s financial materiality.

No such thing as a free lunch

While sustainable businesses like solar panel installers will see rich business opportunities, many traditional businesses could face significant business risks from this “green turn”. For instance, firms that once got away with paying workers US$7.25/hour ($9.73/hour) could find themselves high and dry as the Biden administration raises the minimum wage to US$15/hour. Incumbents do not tend to fare well when faced with disruption.

“Some retailers will be able to adapt due to their competitive positioning or other strengths, and in fact some already have, with bonuses and salary increases since the pandemic began, but many will find that sustainability concerns pose major challenges to their profitability,” caution Almeida and Wilson.

Fossil fuel producers in particular — who receive the most flack for their complicity in climate change — are in for a rough ride as markets swiftly abandon pollutive energy sources. With two-thirds of oil demand tied to automobiles powered by internal combustion engines, the rise of electric vehicles means that this use case is increasingly under threat. Even as they are driven by a rising middle class in emerging markets, the future for such energy sources looks grim.

Almeida and Watson therefore see substantial divergences in the long-term enterprise value of many companies emerging as they collapse under the weight of the resulting disruption. Without significant agility, long-term survival could be a tall order for traditional firms. This will, of course, have implications for the price of financial assets associated with such firms.

According to Chris Bowie of TwentyFour Asset Management, returns dropped 1% per annum when he removed unsustainable firms involved in oil and gas, tobacco, gambling and alcohol while testing his first ESG fund. He tells Bloomberg that these exclusions raised the fund’s volatility since it reduced asset diversification.

Worse, the cost of non-compliance is still not very high. Chris Brils, portfolio manager at Actiam NV, points out that the financial penalties for failing to comply with ESG criteria is still only about five to 10 basis points. “It’s nothing that significant yet,” he tells Bloomberg, tempting investors to hold off ESG transformation. Still, he sees this “get-out-of-jail-free” card slowly fading away if fund managers are forced to comply with more ESG-related investment strategies, allowing ESG to outperform “vice” assets.

Ethics in practice

It is here economics sheds its scientific costume and returns to its roots as a theory of moral philosophy. Having acknowledged that there will inevitably be a cost to humanity’s decision to adopt sustainability, it is an open question as to who should be paying that cost. Given that businesses ought to be responsible for the social costs of unsustainable business practices, it is arguable that they should foot that bill even if it means insolvency.

For a long time, these businesses have arguably been able to stay profitable by discounting the ESG costs of unsustainable business practices. Such costs have typically been borne by collective society in the form of externalities such as crop failures arising from climate change, or social ills such as crime arising from poverty. It is difficult to argue on an ethical basis that these largely innocent third-parties should subsidise ESG costs incurred by businesses.

“The economic cost of climate change is high: an annual US$12 billion increase in electricity bills due to added air conditioning; US$66 billion to US$106 billion worth of coastal property damage due to rising seas; and billions in lost wages for farmers and construction workers forced to take the day off or risk suffering from heat stroke or worse,” reports Michael Greenstone, non-resident fellow at the Brookings Institution, a US think-tank.

Factoring ESG costs into investments can therefore be seen not as an additional imposition on bottom lines, but rather pricing in unreflected business costs into firm valuation. With this additional information, market forces are likely to become more efficient while investors can make more informed choices. All the more reason to take into account ESG considerations when picking assets.

Ultimately, it will be market demand that will determine the future of ESG. Bloomberg reports that lenders struggled to find buyers for a US$500 million loan to Israeli “hackersfor-hire” firm NSO Group in 2019 based on accusations that one of its products was used by states to spy on dissidents. Arms company Heckler & Koch was forced to raise funds in the more expensive private market in 2017, three months after mandating Citigroup for a highyield bond sale.

If it is any consolation, the move towards greater sustainability is likely to take time. Wood Mckenzie, an energy consultancy, sees peak demand for oil only arriving in 2039 before gradually declining. If they use this ample time wisely, currently unsustainable businesses may yet survive the ESG revolution.