(Bloomberg) -- A Dutch investment firm with $118 billion under management has started blacklisting a number of assets from China, after developing a new screening tool to catch environmental, social and governance risks.

Van Lanschot Kempen NV, a 400-year-old firm, has created a test that includes a national corruption score, and will start excluding sovereign bonds and state-backed entities from places that don’t pass, said Nikesh Patel, senior executive at the wealth manager. The new strategy will apply to all portfolios across the entire firm, though Patel declined to say how much it’s divesting in total.

The ESG industry this year hit an estimated $40 trillion, according to Bloomberg Intelligence. Its unfettered growth has led it into some questionable markets, with a Bloomberg analysis in March showing that ESG fund managers held everything from Russian government bonds to shares in state-backed oil and gas giants. A separate Bloomberg analysis revealed ESG funds’ huge exposure to China, another autocratic regime.

Such investments are no longer tenable for an ESG fund manager, according to Patel.

“We are trying to identify and avoid controversial countries,” he said. “Countries where controversial actions are more likely to happen because of their approach to the environment or the way they govern their people — the Russia-Ukraine war is an extreme example of this.” 

Patel said Van Lanschot Kempen’s screening tool rates governments on everything from climate change to free speech and corruption. Russia’s invasion of Ukraine underpinned the necessity of the move, but Patel said the firm was working on the tool before the war, driven by frustration over industry applications of ESG.

“You had the creation of a Chinese government bond index, which was entirely labeled ESG. You had the creation of an emerging market debt index, which excluded or greatly diminished exposure to China but greatly overweighted exposure to Saudi Arabia,” Patel said. “All of these sorts of things ate away at us. Our thinking here was that there had to be a better way to do things.”

Van Lanschot Kempen’s test has also identified some democracies that perform poorly. India “just scraped over the line and is the one most at risk of falling below in the next few updates of the scores,” Patel said.

Even the U.S. raises some red flags. When it comes to “the freedom scores, on democracy, they score better but not perfect,” Patel said. And its track record on the environment means the U.S. “isn’t really anywhere near the top” of the ranking, he said.

Van Lanschot Kempen pools data from a variety of academic institutions and non-government organizations, including Reporters Without Borders, which monitors press freedoms; Transparency International, which measures corruption; and environmental research organization Climate Action Tracker. Countries that fail the test are excluded from the investment portfolio.

The response from clients has so far been mixed, Patel said. Some have voiced concern about the implications for returns.

Telling a client who “only did global fixed income: ‘I’m going to exclude Chinese sovereigns,’ when for the last five years that was the only place you could go to get serious yield,” isn’t an easy conversation, he said.

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