“An excellent tool”: New study by AIMA and Simmons & Simmons probes ESG short-selling ethics

ESG

Short selling is essential in enabling investors to hedge against ESG risks, and has bolstered market transparency by uncovering corporate wrongdoing and environmental negligence, according to a new study by the Alternative Investment Management Association and global law firm Simmons & Simmons.

The paper - ‘Short Selling and Responsible Investing’ - probed how the booming trend of ESG (environmental, social, and governance) investing interacts with short selling, the often-criticised practice that is central to most traditional hedge fund strategies.

The study found that responsible investing does not necessarily require long holding periods, and suggested shorting can be “an excellent tool” for achieving two key goals for responsible investors: mitigating undesired ESG risks, such as climate damage, and creating an economic impact by influencing the nature of capital flows through ‘active’ investing.

ESG is now seen as a key factor in many hedge funds’ portfolio-building processes, as boardrooms grapple with ongoing challenges such as climate change and improving corporate governance. 

Hedge fund managers themselves are growing increasingly strident in fusing bearish bets with a socially-conscious outlook. High-profile firms including Sir Chris Hohn’s TCI Fund, Caxton Associates, and Man Group have become prominent advocates.

But debate still rages over the ethics of short selling, and whether the practice ultimately contradicts the spirit of responsible investing.

Jack Inglis, CEO of hedge fund trade association AIMA, said alternative investment managers have always been at the forefront of investment innovation, adding that short-selling – “one of their defining abilities” – helps protects investors from risks.

“We have no doubt that short selling will soon be seen not just as valuable for responsible investment, but essential,” he said.

The report said short positions can be used to trade on ESG concerns over corporate governance, environmental issues, and alleged human rights abuses, among other things – in turn, exposing failings of issuers and bolstering market transparency for investors.

Specifically, it spotlighted short-sellers’ early public campaigns against Wirecard AG, the scandal-hit German e-payments firm which last month collapsed amid accounting fraud.

“To dismiss short selling as not having a role to play in the context of ESG would be naïve,” Darren Fox, partner at Simmons & Simmons, said of the report’s findings. “One only has to look at the recent events relating to Wirecard to realise that short selling has an important role to play within the ESG framework.”

Quentin Dumortier, founder and CIO of Atlas Global Investors, a responsible investing-focused long/short equity hedge fund, said shorting can put pressure on stock prices of companies and forces management “to take note and correct it by doing the right things.”

“Some people take issue with the fact that funds are shorting, and feel that betting against a company is something that’s morally wrong,” Dumortier told Hedgeweek in an interview earlier this year. “The idea is to call the bluff between what companies say, and what they actually do. We believe that consumers, regulators and market participants will increasingly punish companies that are not truly ESG compliant, or those active in non-sustainable trends.”