ESG funds must tread carefully as Russian sanctions bite | Patterson Belknap Webb & Tyler LLP

The full-scale invasion of Ukraine by a vengeful Russia continues to grab headlines as the war enters its second month. While the sometimes dire choices facing those living in the conflict zone are unprecedented, investors around the world also have choices to make. Among these, ESG funds that are tasked with minimizing the investment risks associated with environmental, social and governance issues face difficult – and sometimes contradictory – dilemmas.

Russia is one of the world’s leaders in hydrocarbon extraction, behind only the United States and Saudi Arabia in crude oil production in 2020.[1] Europe’s dependence on Russian natural gas appears to have reinforced the Putin administration’s belief that EU countries would not take strong and united action against Russian aggression, as European countries depended on Russia to more than 38% of their gas imports on average.[2] At the same time, the Russian economy is widely perceived to suffer from significant levels of corruption, with Russia consistently ranking between 135 and 138 out of 180 countries surveyed (higher is worse) over the past decade.[3]

Given the heavy reliance of the Russian economy on fossil fuel exports and the persistent perception of corruption, one would expect ESG funds to have low exposure to Russian assets. A Bloomberg survey was able to confirm 300 ESG funds with $8.3 billion directly invested in Russia. While this is a significant exposure, it represented 6.25% of the 4,300 funds surveyed and less than 0.5% of their $2.3 trillion in total assets under management.[4]

It is important to note that each ESG fund incorporates these principles differently, as outlined in the fund’s offering documents. This has given ESG funds wide latitude and discretion to implement ESG policies. Some funds forego certain industries, while others may invest in the “cleanest dirty shirt”, that is to saycompany in a troubling industry that demonstrates the greatest commitment to improvement.[5]

This discretion is now a source of friction in some cases, as ESG fund managers face calls to exit investments that directly benefit – or in some cases are even indirectly linked – to Russia’s efforts to expand its subjugation to Ukraine beyond Crimea and Donbass. Since fund managers can wield substantial power in executing a fund’s ESG policies, their decisions, in some cases, to delay divestment have come under strong scrutiny.

The conundrum of ESG funds stems from the pressure to divest from Russian assets in a climate where Russia is systematically isolated from the global economy. Historically, ESG funds have been able to rebalance portfolios in a market where counterparties were more concerned with returns than sustainability. In the current climate, however, ESG funds face significant hurdles in finding buyers for Russian assets, as sanctions now extend to traditionally neutral countries such as Cyprus, Sweden and Switzerland. For example, Blackrock, the world’s largest investment manager, recently revealed that it had written down $17.2 billion of its Russia-related assets – almost 95% of their value – and suspended purchases of all Russian securities.[6]

Even funds that aren’t technically ESG funds have wondered how best to reduce investments in Russian operations. For example, the California Public Employees Retirement System assessed how to respond to Governor Gavin Newsome’s call for California state funds to divest from Russia. A report said CalPERS’ initial review showed that a hard sell would require booking a near total loss.[7]

China’s disappointing support for Russia’s expansionary effort has further heightened concerns for ESG funds. Despite decades of growing commercial ties between the United States and China, at least one prominent ESG adviser is now warning that ESG funds should classify both Russia and China as “uninvestable.” As Bloomberg reported, Paul Clements-Hunt, who led a group that coined the term ESG in the mid-2000s, said, “If you ignore autocracy and bad government, then you failed your ESG assessment. ”[8]

While funds like CalPERS can afford to have at least a modicum of time to arrange a reasonable exit from Russian assets, ESG fund managers will need to review the terms set out in their funds’ offering documents and, if necessary , working closely with to understand their ability to balance the legal requirements of their strategies and their goals of protecting and growing clients’ investments.

[1] PB, World Energy Statistical Review, 70th 18 (2021) available at

[2] Sullivan & Northam, How Europe’s Reliance on Russia’s Gas Plays into the War in Ukraine, NPR (February 24, 2022).

[4] Marais & Schwartzkopf, ESG funds had $8.3 billion in assets in Russia just before the warBloomberg (March 8, 2022).

[5] Environmental, Social and Governance (ESG) Funds – Investor BulletinSEC (February 26, 2021).

[6] Kerber, BlackRock Russia exposure down $17 billion since February, firm data showsReuters (March 11, 2022).

[7] Lim & Massa, Calpers Conundrum: a $300 million stunt to lay bets on RussiaBloomberg (March 10, 2022).

[8] Kishan et al, ESG finds itself at a crossroads after investing in Putin’s Russia (7 March 2022).

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