ESG (Environmental, Social, and Governance) funds have once again come under scrutiny, with many holding shares in Adani Green Energy Ltd., which recently lost a quarter of its value after U.S. prosecutors filed charges against its owner, Gautam Adani, with bribery. This incident exposes the flaws in ESG fund screening processes, as Adani Green’s governance issues were overlooked despite its commitment to sustainable energy, revealing a significant gap in the ability of ESG funds to properly assess governance risks.
Adani Green, one of the companies of Adani Group, is in the middle of an issue after U.S. authorities charged Gautam Adani, its owner, with orchestrating a $250 million bribery conspiracy. The alleged bribes were intended to secure solar energy contracts from Indian government officials. This came nearly two years after Hindenburg Research published a report accusing the Adani Group of years of fraud and market manipulation. The latest developments have wiped roughly $27 billion from the market value of the Adani Group, further damaging investor confidence.
Although the Adani Group has denied the allegations, the fresh wave of scrutiny has led many investors, especially those in ESG-focused funds, to reevaluate their holdings in Adani Green. Despite being marketed as an environmentally conscious company, Adani Green now faces growing concerns over its corporate governance and ethical standards, with these issues bringing its ESG ratings into question.
Around 770 ESG funds globally have investments in Adani Green Energy, collectively worth roughly $400 billion. Many of these funds are marketed as promoting environmental, social, and governance metrics, yet have faced criticism for overlooking serious governance issues within the companies they back.
Adani Green was considered a leader in the renewable energy sector, with a target to generate 50 gigawatts of renewable energy by 2030. However, the recent allegations against the company have left investors questioning whether ESG funds are adequately screening companies for governance risks. ESG funds are supposed to apply more rigorous analysis to protect clients from investments that may pose environmental, social, and governance risks. However, these funds have repeatedly failed to prevent exposure to controversial companies, as seen in their past holdings of Russian assets during the Ukraine invasion and their failure to address or respond to what happened to Silicon Valley Bank in 2023.
In 2022, Mohit Mirpuri, a portfolio manager at SGMC Capital, was one of the investors who sold their Adani Green bonds due to concerns about the company's significant dependence on leverage. He argues that there is now “no case to be made” for holding shares in Adani Green, especially as the company faces mounting legal and regulatory risks. The continued presence of Adani Green in ESG portfolios “calls into question” whether fund managers are truly screening for governance risks or simply using ESG labels to attract investors.
For many long-time critics of ESG investing, the Adani Green scandal is the latest in a series of failures that highlight the weaknesses of the ESG movement. Barry Norris, the founder of UK hedge fund Argonaut Capital Partners, described the scandal as evidence that the ESG industry can easily “house malfeasance, chicanery, and skulduggery” under the guise of morality. He argued that the ESG industry’s focus on environmental and social issues often leads to a blind spot when it comes to assessing the core issue of corporate governance.
The Adani Green case has also raised questions about the effectiveness of ESG ratings agencies. MSCI Inc., which initially gave Adani Green an “A” rating, downgraded the company to a “BBB” rating in mid-2023, following the Hindenburg report. MSCI stated that it was “closely reviewing” the situation and flagged concerns over business ethics and fraud allegations, including bribery. Similarly, Morningstar Sustainalytics, known for assessing companies’ sustainability risks, categorized Adani Green with a “medium” governance risk score and indicated that the company was involved in a notable controversy.
While MSCI and Morningstar have begun reviewing their ratings, the fact that Adani Green was able to attract ESG investments in the first place underscores the flaws in the current system of ESG due diligence. As Hortense Bioy, global head of sustainability research at Morningstar, noted, the company has “negligible risks related to material environmental and social issues” but a “weak business ethics program” and a “weak political involvement policy.” These gaps in the ESG assessment process raise the question of whether these agencies are doing enough to ensure companies meet the high standards they claim to uphold.
The irony of the Adani Green scandal lies in the stark contrast between the company’s strong environmental track record and its poor governance performance. While Adani Green has been lauded for its efforts to expand India’s renewable energy capacity, it has failed to address serious issues of corporate governance and ethical practices. This contradiction highlights a core problem in the ESG framework: the focus on environmental and social issues often overshadows the crucial element of governance.
The Securities and Exchange Commission (SEC) has also pointed out the “dichotomy” of ESG, noting that many investors chose to ignore red flags surrounding Adani Green because of its role in the sustainable energy sector. This situation reveals the “blind spot” in the ESG system—investors may prioritize environmental impact without fully considering whether a company adheres to ethical and transparent business practices.
The Adani Green crisis presents a major test for the ESG industry and underscores the need for better screening and more rigorous standards. Investors, regulators, and ESG ratings agencies must take a more comprehensive approach to evaluating companies, considering not only their environmental and social contributions but also their corporate governance and ethical conduct. If the ESG movement is to retain credibility, it must address these governance gaps and ensure that companies like Adani Green are held accountable for their actions.
As the ESG landscape evolves, the Adani Green scandal will likely serve as a cautionary tale about the risks of relying too heavily on environmental and social metrics without properly assessing governance. The industry must adapt and strengthen its due diligence processes to avoid further embarrassments and ensure that ESG funds truly serve the interests of investors and society at large.
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