After years of seemingly unstoppable momentum behind ESG, the sustainable investment space witnessed heightened debate in 2022.
This was largely driven by political posturing in the US, as the divide between anti-ESG ‘red states’ and pro-ESG ‘blue states’ widened. The uncertainty stemming from the anti-ESG camp is unlikely to abate over the coming year or so, particularly as we move closer to the 2024 US presidential election.
Market dynamics also played a role in the intensified focus on ESG, as sectors not traditionally aligned to sustainability – such as oil and gas – saw strong gains as a result of the Russian invasion of Ukraine. This may have tempted some investors to de-emphasise their long-term sustainability goals in a bid to capture short-term upside.
Nevertheless, we are as confident as ever about the long-term prospects for sustainable investing, and do not believe the negative headlines reflect the reality of the situation – at least outside the US.
In actuality, the integration of ESG/sustainability into investment decisions is increasingly becoming mainstream globally, driven both by regulatory activity and by real-world concerns. Research by Dow Jones in September 2022 showed ESG investment is expected to more than double over the next three years, while 66% of financial leaders named ESG investing as the number one driver for sustained, long-term growth.
The multiple long-term tailwinds
Certainly, the ESG regulatory revolution will not be easing off any time soon. Globally, an increasing number of jurisdictions are introducing rules and taxonomies governing ESG investing and company disclosures – such as the UK, US and Singapore. These are often modelled on existing EU directives – such as the SFDR, the EU green taxonomy and CSRD.
Ongoing regulatory initiatives are expected to increase investor demand for ESG considerations to be taken into account, either indirectly, or – as in the case of the EU’s Mifid regulation last year – directly mandating sustainability concerns be part of an investment advice session.
At the top level, even though COP27 was not universally regarded as a success, the Kunming-Montreal Global Biodiversity Framework was agreed at COP15, which will likely inspire new legislation over the coming years. A number of major sustainability regulations have already been enacted – such as the new EU law on deforestation-free products, which also requires safeguards on human rights, and the Uyghur Forced Labor Prevention Act in the US.
With issues such as climate, biodiversity and human rights at the top of the agenda for authorities, companies unable to live up to the rising level of due diligence required will be increasingly locked out of the world’s largest markets. This poses risks for investors, which means thorough ESG analysis will continue to be imperative.
And even without the regulatory tailwinds, the power of public opinion should not be underestimated. As we are increasingly confronted with visions of extreme weather events and biodiversity loss, retail investors are likely to become more conscious of the connection between their investments and sustainability factors. As for institutional investors, while we saw a handful of cases of backtracking in terms of climate commitments, these were overwhelmingly dwarfed by the number of entities seeking to strengthen sustainability pledges.
The label is inconsequential
As 2023 progresses, the longstanding discussion surrounding the term ‘ESG’ is poised to continue – particularly with its ongoing politicisation in the US. However, with no consensus of an alternative classification to the current catch-all of ESG, we do not expect to see any near-term change to the current status quo.
In any event, regardless of whatever terminology we will coalesce around at some point, the investor sustainability surge is not only here to stay, it will only accelerate.