Amid a backlash in the US, is there a future for ESG investing?

ESG – environmental, social and corporate governance – investing was supposed to be a noble call to arms for the global investment community, an opportunity to bear responsibility for the future of the planet and its people by ploughing money into companies that espouse the best of these values.

Yet in recent years enhanced politicisation of the term, especially in the United States, has led to something of a backlash, to the point where the term ESG is being quietly discarded. Semantics aside, does this mean these values are no longer a priority for investors?

Eileen Rowsome, director of responsible investment with Davy Private Clients, says momentum in ESG investing had been steadily increasing for several years, for many reasons.

“Companies themselves are increasingly focused on improving their sustainability and governance profiles in pursuit of both revenues and a more favourable perception from customers and shareholders,” says Rowsome.

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“Secondly, investors are becoming more focused on the impact of their investments and a much wider group of investors is interested in sustainability today than 10 or 15 years ago. And thirdly, the data in the space has improved considerably – there are many more ways to measure the ESG characteristics of an investment now than there were even five years ago.”

However, Rowsome admits that it can be daunting for investors to interpret all of these measures.

“This can all be very confusing and hasn’t helped investors. At Davy we talk about Socially Responsible Investment, which is the activity that gives environmental, social and governance factors important consideration in the investment process. Most people would like to consider sustainability but it needs to be understandable and the benefits and potential costs need to be clearer.”

Rowsome admits that what ESG actually constitutes can often be “vague”; Dr Thomas Macagno, Education Innovation Lead at the UCD Innovation Academy and expert in sustainable business, agrees. He blames the “lack of cross-cutting standards” and resulting lack of clarity when it comes to ESG’s recent loss of credibility.

“Without those standards people were promoting things that didn’t have the underlying fundamental deliverance on sustainability or ESG,” he says. A pushback was “almost inevitable” as accusations of greenwashing muddied the waters.

“From an investor point of view, they were most interested in ESG addressing risk and embracing opportunity, and without clear standards they feel like they were exposed to undue risk and opportunities that were promised are now in question.”

And the impact of ESG went far beyond investors, Macagno maintains.

“Certain groups have disproportionately had pressures put on them to address sustainability – for example, farmers feel that they are being put under undue pressure,” he says. “The sentiment that ‘you can’t tell us what to do’ is now playing out more broadly.”

This is especially acute in the US, particularly in so-called red or Republican states. These tend to be economies which are more reliant on traditional energy sources, says Rowsome.

“We have seen large US-based asset managers row back on commitments to industry initiatives like Climate Action 100+ due to pressure from the anti-ESG movement,” she admits.

However, this has not necessarily been reflected in Europe to date.

“In some instances the asset manager’s international or non-US business remains committed,” says Rowsome. “At this point, we haven’t seen the same reaction in Europe, where state support for energy transition is perhaps more embedded.”

New legislation such as the EU’s Corporate Sustainability Reporting Directive, due to be transposed into law this year, as well as the Securities and Exchange Commission climate regulations in the US, will require companies to accurately report on their emissions (although the US legislation is much narrower in scope and is already facing multiple legal challenges). This will result in a critical shift in approach to defining true sustainability, says Macagno.

“At the moment if you look at how funds were screened they maybe didn’t go under the hoods with the companies they were including, instead just looking at sustainability reports or use surveys; there were no objective standards,” he explains.

“These things go in peaks and troughs – ESG is in a trough at the moment but when we start to see clear standards emerge we will see the underlying concerns addressed, hopefully. I certainly don’t think it’s time to despair.”

Nonetheless, ESG investing is likely to be renamed in an effort to rid itself of any negative connotations. Macagno recalls his interactions with farmers while he was working in the US, noting: “If you spoke to a farmer and mentioned sustainability, they would be suspicious and say that’s politics and they didn’t want anything to do with it, but if you asked them if they were concerned about unpredictable weather and how it is impacting crop yield then they were far more receptive.

“The political associations with these terms such as ESG are unfortunately negative and I believe they will be rebranded in a way that people can relate to them more readily.”

According to Rowsome, there are already “green shoots”.

“If you look at the Inflation Reduction Act, for example – it has created jobs all over the US. E2, an environmental non-profit, estimates that half the projects announced and 67 per cent of the jobs in the clean energy space since the bill was enacted are in Republican districts.

“And while there is an election looming, whoever the winner is will find it difficult to row back on job creation.”