The Carbon Mirage of ESG Funds: How Sustainable Finance Became a Branding Exercise

By Jacob Petersen Apr. 9, 2025

Sustainable investing promised a moral revolution in finance—a world where profit aligned with planetary health. Yet as trillions of dollars have flowed into Environmental, Social, and Governance (ESG) funds, evidence increasingly shows that many of these products are less “green finance” than green theater. Behind glossy annual reports and verdant branding, ESG portfolios continue to channel vast capital into high-emission industries under the veil of sustainability ratings.

According to the Morningstar Sustainable Assets Survey (2025), global ESG assets under management surpassed US$41 trillion, representing nearly one-third of total global investment. But the OECD Financial Integrity Review (2025) found that over 60 percent of these funds hold companies in fossil fuels, mining, or high-carbon manufacturing. ESG investing, it seems, has become less a climate solution than a marketing category.

The Mechanics of Greenwashing

At the core of the ESG illusion lies the rating system itself. There is no universal standard—only competing methodologies. MSCI, Sustainalytics, and Refinitiv each assign scores based on different metrics, often rewarding corporate disclosure rather than actual impact. A MIT Sloan Management Review (2024) study comparing major ESG raters found an average correlation of only 0.54 between their scores—roughly the same as the correlation between height and intelligence.

This variance allows corporations to arbitrage their virtue. ExxonMobil, for instance, ranks above Tesla on several ESG indices because its governance structure appears “stable” and it discloses climate risks more comprehensively. The Financial Times ESG Consistency Report (2024) calls this phenomenon transparency bias—companies receive higher sustainability scores not for emitting less, but for describing their emissions better.

In effect, ESG has turned climate disclosure into a linguistic competition.

The Carbon Accounting Shell Game

The deception deepens in carbon accounting. Under the Greenhouse Gas (GHG) Protocol, companies divide emissions into three scopes: direct (Scope 1), purchased energy (Scope 2), and value chain (Scope 3). Most ESG portfolios ignore Scope 3 emissions—responsible for up to 87 percent of total corporate carbon output (CDP Global Emissions Dataset, 2025).

This selective accounting allows asset managers to advertise “low-carbon” portfolios filled with retail, logistics, and tech companies whose upstream suppliers burn fossil fuels at scale. Amazon’s Scope 1 and 2 emissions fell 10 percent in 2024, but its Scope 3 rose 18 percent—the portion investors rarely see.

The result is an inversion: the greener the fund appears, the dirtier its supply chain becomes.

The Social and Governance Mirage

Even the non-environmental pillars of ESG have lost coherence. “Social” metrics lump together everything from gender diversity to cybersecurity, while “Governance” can reward stability in regimes with limited transparency. The World Bank Corporate Governance Benchmark (2025) reveals that several authoritarian-linked corporations rank in the global top 10 percentile for governance—simply for having consistent executive leadership.

In short, ESG frameworks mistake predictability for ethics.

The Financialization of Morality

The ESG boom is not about climate—it’s about liquidity. Institutional investors have rebranded traditional funds to attract ethically conscious capital. The London School of Economics Finance Division (2025) found that 78 percent of ESG funds are repurposed conventional portfolios with minor reallocation. Once reclassified, these funds charge management fees 23 percent higher than non-ESG equivalents.

In other words, sustainability sells. BlackRock’s CEO Larry Fink famously declared in 2020 that “climate risk is investment risk,” yet by 2025, BlackRock remains one of the largest shareholders in Chevron, ExxonMobil, and Shell (Reuters Corporate Ownership Database, 2025). ESG has become a tool for optics management, not emissions reduction.

The Regulatory Wake-Up Call

Governments are beginning to intervene. The European Securities and Markets Authority (ESMA 2025) introduced the “Greenwashing Directive,” requiring funds labeled “sustainable” to derive at least 80 percent of investments from independently verified low-carbon assets. Early audits found that 71 percent of funds would fail this threshold under current holdings.

The United States is following suit. The Securities and Exchange Commission (SEC) has proposed mandating Scope 3 disclosure for all public companies and enforcing civil penalties for misleading ESG labeling. However, the Harvard Law School Forum on Corporate Governance (2025) notes that lobbying by financial institutions has already delayed enforcement beyond 2026.

The ESG industry thrives in this regulatory gray zone—profiting from moral aspiration while avoiding measurable accountability.

Emerging Alternatives: From Metrics to Mechanisms

To restore credibility, reformers advocate moving beyond ESG scoring toward outcome-based models:

1. Impact-Weighted Accounting – Developed by Harvard Business School, this system converts environmental and social externalities into monetary values, directly adjusting net income for real-world impact.

2. Science-Based Portfolio Alignment – The Science Based Targets initiative (SBTi) certifies funds whose investments align with Paris Agreement trajectories rather than relative benchmarks.

3. Regenerative Finance (ReFi) – Web3 and blockchain models tie capital flows directly to verified carbon or biodiversity credits, ensuring traceability.

While promising, these frameworks remain nascent. The World Resources Institute (WRI 2025) warns that without global harmonization, “impact inflation” may replace greenwashing with a new form of numerical theater.

The Future of Sustainable Capitalism

The ESG era reveals a fundamental tension: markets crave moral legitimacy but resist moral constraint. The next decade will determine whether sustainable finance can evolve from rhetoric to reformation.

If left unreformed, ESG risks becoming the financial sector’s equivalent of the carbon offset—a way to feel virtuous while changing nothing. But if restructured toward verifiable outcomes, it could still fulfill its founding promise: aligning capital with consequence.

At present, however, the sustainable finance revolution remains mostly cosmetic—proof that capitalism can market conscience faster than it can manufacture change.

Works Cited

“Sustainable Assets Survey.” Morningstar Research, 2025.

 “Financial Integrity Review.” Organisation for Economic Co-operation and Development (OECD), 2025.

 “ESG Rating Correlation Study.” MIT Sloan Management Review, 2024.

 “ESG Consistency Report.” Financial Times, 2024.

 “Global Emissions Dataset.” Carbon Disclosure Project (CDP), 2025.

 “Corporate Governance Benchmark.” World Bank Group, 2025.

 “Finance Division Working Paper.” London School of Economics, 2025.

 “Corporate Ownership Database.” Reuters, 2025.

 “Greenwashing Directive.” European Securities and Markets Authority (ESMA), 2025.

 “Forum on Corporate Governance.” Harvard Law School, 2025.

 “SBTi Fund Alignment Framework.” Science Based Targets Initiative, 2025.

 “Sustainable Capitalism Report.” World Resources Institute (WRI), 2025.