Despite the backlash, ESG is here to stay

CRITIQUES of environmental, social, and governance (ESG) considerations in investing have increased significantly over recent months. This attention and pushback are, if anything, evidence of how much traction responsible investment has gained, and perhaps of a maturing of the sector. But at the same time this has understandably also raised questions among investors, and while ESG incorporation is not new, many are new to it.

Some investors may be wondering whether to continue embracing ESG incorporation when it is receiving so much negative scrutiny. So should they? The answer is, without question, yes.

ESG incorporation is about considering information that can be material to the value of investments, and ESG investing practices are largely driven by investor needs. As such, ESG factors are not separate from fundamental investment analysis; they represent a natural evolution in the data that is available to – and considered by – investors in their decision making.

Whether used to assess how companies are responding to gender equity issues, or how they are implementing goals to reduce carbon emissions, ESG factors provide insights into how companies consider and respond to inputs that can impact their short and long-term success. Increasingly, asset managers understand that their duty to fulfil their obligations to clients can be impacted in fundamental and lasting ways by ESG trends – and the sustainability outcomes that result from them.

Using ESG information to align portfolios with those trends can be good for gaining business today and protecting portfolios and clients in the future. In this way, ESG factors provide information that investors need to achieve their investment goals and fulfil their fiduciary duties.

In this context, it’s interesting to note that United States Treasury Secretary Janet Yellen recently said: “The flow of capital from carbon-intensive to carbon-neutral investments is probably the most dramatic and predictable economic shift in human history. The transition is happening already.”

With such a profound shift in investment flows unfolding, it’s hard to argue that it won’t come with benefits – in terms of both investor returns as well as contributing to sustainable outcomes by mitigating climate change through the reduction of carbon emissions.

Our role at the Principles for Responsible Investment is to support investors around the world in their efforts to better access and incorporate ESG information in investment decision making. We provide best practice guidance, enable collaboration between our signatories, and engage with regulators to highlight to them the consideration of potentially material ESG information.

ESG integration is an evolving practice, and investors, governments and regulators are at different stages of that evolution across the globe, with developed economies further down the road in terms of regulation and definitions. The comprehensive European Union Green Taxonomy has set the standard in this regard, and is being used as a template in developed countries in Asia, with developing nations in the region fast catching up.

Encouragingly, our regulation database shows that regulators globally are setting standards to improve the integrity and efficient functioning of markets regarding ESG incorporation. To push investors to ignore ESG information would mean neglecting data that can impact the risk and returns of an investment – for example, the risk of policy and regulatory action causing stranded assets or presenting immense reputational damage.

This doesn’t just risk missing important information – it could be a violation of asset managers’ fiduciary duties to clients. The PRI’s Legal Framework for Impact project has explored this in more detail, examining the extent to which institutional investors are legally required or permitted to invest for sustainable impact. Inputs such as net zero carbon emissions targets at national and corporate level are driving regulatory reform, and in numerous global jurisdictions ESG-aligned investing is becoming mandatory as a constituent of stewardship and fiduciary duty.

Around the world, there is immense work being done to better develop and align ESG practices for lasting effect. Adoption of recommendations from the Task Force on Climate-Related Financial Disclosures continues to grow, with over 2,600 organisations globally having done so. Meanwhile the International Financial Reporting Standards Foundation, whose accounting standards have been adopted by 140 countries, is working on a baseline set of climate-related ESG disclosures.

As well as the European Union, the US Securities and Exchange Commission has proposed similar requirements to begin setting a baseline of what environmental information means for investors. The PRI is also supporting regulatory efforts to reduce “greenwashing” and ensure savers and investors are getting the services advertised by their investment managers and asset owners, a crucial consideration amid the recent anti-ESG backlash.

More work must be done to establish how ESG incorporation can be better adopted across financial markets, and the focus should be on delivering transparent, actionable information for asset managers, institutional investors and beneficiaries.

There are more than 5,000 PRI signatories representing some US$120 trillion in assets. These investors have made it clear that they consider ESG factors because of their materiality to the value of investments. To ensure better decision making by investors, open discourse on how ESG incorporation will evolve in a rapidly changing market should be welcome. But for this to be productive, we need to focus on how appropriate approaches deliver vital transparency and enable markets to work to improve investment outcomes.

The writer is chief executive officer of the United Nations-supported Principles for Responsible Investment