After a relative honeymoon during the pandemic years, sustainable investing faced a reckoning in 2022. Environmental, social and governance (ESG) fund labels came under greater scrutiny amid greenwashing accusations, while soaring prices for oil and other commodities tempted some fresh converts to return to their old habits.
As recession fears come to a head in 2023, the ESG world faces two battlefronts: One in the US political arena and the other against mounting costs of living worldwide.
For example, US Republican politicians are leading a push back against climate-focused activist shareholders.
Meanwhile, West Virginia barred five major financial institutions from new state businesses for taking a stance against the fossil fuel industry last July.
West Virginia state treasurer Riley Moore accused BlackRock, JPMorgan, Goldman Sachs, Morgan Stanley and Wells Fargo & Co of “categorically limiting commercial relations with energy companies engaged in certain coal mining”.
The state’s investigation initially included another bank — US Bancorp. It was taken off the blacklist after the bank removed policies against financing coal production, says Moore. US Bancorp insists it did not bow under pressure, and its new policies were already in place before the West Virginia law.
See also: ESG investing: Losing steam or teething problems?
The move prompted similar actions in other red states. Florida, for example, announced in December last year that it would pull some US$2 billion ($2.6 billion) previously managed by BlackRock in retaliation for these alleged boycotts. In recent years, BlackRock’s billionaire CEO Larry Fink has emerged as one of the loudest proponents of ESG investing.
Political momentum for ESG slowed last year, writes Schroders global head of sustainable investment Andy Howard in a Nov 29, 2022 note.
The United Nations COP27 climate summit in Egypt in November 2022 did little to cement global commitments to action. “That said, agreement on a ‘loss and damage’ fund to help developing nations should ease one key challenge to delivering the changes needed to reach the goals laid out in Paris in 2015. Attention will turn to COP28 in the UAE later in 2023,” he adds.
See also: MAS sets emissions reduction targets, disclosure guidelines for retail ESG funds
Investors, however, may be numb to these high-level machinations. Dutch asset manager Robeco cites Morningstar data from 3Q2022, which recorded net inflows into sustainable funds of US$22.5 billion, compared to outflows of US$198 billion in their overall global fund universe over the same period.
“The increase in sustainable investments as a proportion of total assets under management (AUM) comes despite politically motivated critiques of ESG in the US, where some state governments are claiming ESG-related exclusions discriminate against domestic industries, especially oil, gas and coal,” says Robeco in its 2023 sustainable investing outlook.
“The drivers of this backlash against ESG are transparent,” adds the asset manager.
Some are fund managers using the media to talk about their book, typically a basket of fossil fuel investments without ESG integration, and some are politicians using ESG as another front in the so-called ‘culture wars’.
Despite this, the momentum behind sustainable investing appears unstoppable, says Robeco. In a research released in October 2022, PwC reported that 81% of US investors planned to increase allocations to ESG products over the next two years and that ESG-oriented AUM in the US is expected to double to US$10.5 trillion by 2026.
A more mature approach to ESG
Under pressure from politicians and investors, Fidelity International expects firms to “get real” on ESG in 2023. Volatile markets create a stark contrast between the needs of different stakeholders and the choice they face of integrating ESG for value or values, says Tan Jenn-Hui, global head of stewardship and sustainable investing for Fidelity International.
See also: Is your financing really green?
“As a result, a new, more mature approach to ESG integration is emerging — one that acknowledges the necessary trade-offs between the short-term decisions required to remain in business versus the longer-term needs of customers, employees and communities,” writes Tan in December last year.
He adds that some companies with net zero plans have found them more challenging to implement in 2022 due to higher material and energy costs and disrupted supply chains, while others have benefited from clean energy investments already made.
Many nations have had to revert to fossil fuel power generation to keep the lights on — literally — and to protect the economy, while still planning for a more secure, affordable and sustainable energy future.
While climate change remains an existential threat, Schroders’ Howard acknowledges that it will fall behind the immediate concerns of citizens and governments.
“A cost of living crisis has taken grip in many countries, and while the most acute pressures may decrease in 2023, poverty is a threat we will be monitoring. Few governments have the fiscal capacity to absorb shortfalls in household budgets, and social stresses could intensify. Companies are under pressure to protect vulnerable workers through wage increases and benefits for their employees or their responsibility to workers in supply chains.”
The cost of living and income inequality will emerge as this year’s key focus areas for proponents of sustainable investing, says Robeco. “In the long run, the issues are interconnected, as energy shortages and climate-related disruptions to the food chain are major drivers of increased living costs.”
Why would this happen in 2023? The cost of living crisis is a ticking time bomb, says Robeco. “The impacts are being absorbed through people running down savings or using credit, but the crunch will come, and at that point, there will be pressure on companies to raise wages, especially those that employ at the lower end of the income spectrum.”
A “curious” macroeconomic backdrop with “very tight” labour markets means companies will have to act, adds Robeco.
“The obvious sectors are companies in the gig economy, extending to sectors with high numbers of generally lower-paid workers, such as logistics, fast food and retail. Inflation pressures are also feeding through to emerging markets, so industries with complex supply chains like fashion are likely to face renewed scrutiny.”
A greater emphasis on the social element of ESG has long been anticipated, says Robeco.
We think the economic environment of 2023 might prove the tipping point.
Regulators step in
The US Securities and Exchange Commission (SEC) proposed in 2022 three rules, aiming to clarify ESG labels and provide investors with more insight into companies’ climate-related financial risks.
These rules will compel listed companies to provide detailed disclosures on climate risks that are likely to have a material impact on their businesses, including greenhouse gas emissions.
The SEC missed its initial October 2022 deadline to publish these new rules; analysts now expect the SEC to release them in 1Q2023.
This takes US regulations closer to EU standards that already require such disclosures.
In the UK, the Financial Conduct Authority (FCA) has announced new rules, expected to come into force in mid-2023, establishing objective criteria for ensuring sustainable investment products are labelled accurately.
Here, climate disclosures will become mandatory from FY2023 for Singapore Exchange-listed companies in the financial, agriculture, food and forest products, and energy industries. Materials, buildings and transportation industries must do the same from FY2024.
Financial institutions here have also issued climate-related disclosures since June 2022 under Monetary Authority of Singapore (MAS) rules. MAS’s disclosure and reporting guidelines for retail ESG funds — announced in July last year — also came into effect this month.
ESG-labelled funds sold to retail investors in Singapore must provide information on investment strategy, criteria, and metrics used to select investments, risks, and limitations associated with the fund’s strategy.
MAS requires the disclosures to be made on an ongoing basis, and investors will receive annual updates on how well the fund has achieved its ESG focus, says managing director Ravi Menon. “The new guidelines will help to reduce greenwashing risks and enable retail investors to understand better the ESG funds they invest in.”
Foreign regulators are flexing their muscles as needed. In November 2022, the European Central Bank (ECB) warned banks that failing to tackle their financial risks from climate change will result in higher capital requirements and fines. By March, the ECB expects banks to categorise climate and environmental risks adequately and thoroughly assess their impact.
By the end of the year, the ECB expects banks to include the climate and environmental risks in their governance, strategy and risk management.
“For those of us focused on sustainability in the investment industry, the last few years have felt incredibly busy,” says Schroders’ Howard. “Keeping up with the scale and pace of regulatory change has been challenging enough.”
The environment for ESG may remain challenging in 2023, says Fidelity’s Tan, but the climate crisis is here. “Many transition areas are starting to accelerate as companies and investors increasingly realise that there is no turning back, whether for energy security reasons or to avoid future climate disasters.”
