In the build-up to the 2020 U.S. presidential election, the future of Environmental, Social and Governance (ESG) investing as a driving force in asset management was questionable. The stark contrast between the Trump and Biden agendas, coupled with an equally divided constituency, made certain one thing – that nothing was certain. While the election itself was marred by social unrest and controversy, it wasn’t long before the direction of policy took shape. In the first 100 days, the new administration took actions to signal that the global issues addressed by ESG initiatives would be a top priority.
The commitment of the administration was quickly evidenced by several headline actions including:
- Re-joining the Paris Climate Accord
- Pledging to invest $2 trillion in infrastructure and clean energy initiatives
- Signing an executive order to revise fuel economy standards
- Retracting enforcement of Department of Labor (DOL) rules restricting investment in ESG strategies
- Revoking the construction permit for the controversial Keystone XL Pipeline
- Reopening a dormant $40bn loan program for clean energy projects
- Pledging to cut greenhouse gas emissions in half by 2030
The implications of these actions have not been overlooked. Large institutions have already begun actively screening managers based on ESG & Responsible Investing (RI) factors (and poised to increase). New ESG funds and ETF’s are announced regularly, and amassing record inflows of new capital. Flows into sustainable open-end and exchange-traded funds available to U.S. investors reached $51.1 billion in 2020, a substantial increase from 2019 when flows were $21.4 billion, and nearly a tenfold increase from 2018, when flows were $5.4 billion (Morningstar, 2021). Their returns have proven to be comparable to traditional funds with 3 out of 4 sustainable funds placing in the top half of their investment category over the past three years, Morningstar data shows.
With so much money in motion, established third-party data providers (and a multitude of start-ups) are zealously marketing their proprietary data sets to asset managers for integration. Carbon footprint scores, diversity rankings and corruption history (to name a few), all come in an endless variety of shapes and flavors.
Record flows, new products, and ESG scoring based on third-party data sets have regulators recognizing the need for policy changes and standardization. Most notably, President Biden announced that his administration would not enforce Trump-era rules requiring workplace pensions to solely consider financial factors when selecting plan investments or casting proxy votes. Additionally, the Securities & Exchange Commission (SEC) published the recommendations from the Asset Management Advisory ESG Sub-Committee in December regarding disclosure of ESG risks in investment products:
- Requiring the adoption of standards forcing corporate issuers to disclose material ESG risks
- Utilizing “standard setters” frameworks to require disclosure of material ESG risks
- Requiring that material ESG risks be disclosed in a manner consistent with the presentation of other financial disclosures
While social and political momentum to implement changes has accelerated, it hasn’t been without resistance. In energy-producing “oil-friendly” states (Alaska, North Dakota, and Texas among the largest), for example, some lawmakers are introducing legislation that would force states to stop investing in companies that use sustainable strategies to make financial decisions (The Pew Charitable Trusts, 2021).Taxes on fossil fuel production provides a significant source of revenue for those “oil-friendly” states. The opposition is a distinct minority but raises valid concerns that politicians will have to confront in the coming month and years. How can we finance the transition away from a carbon-based economy without significant collateral damage to state economies? Perhaps the next 100 days will be telling.
Embedding ESG factors into the investment process (or the failure to do so) represents both a genuine threat to each asset management business and an exciting opportunity. Every business needs to take steps to mitigate the risks and protect current business. A smaller number will successfully make the transition to the new landscape to seize the opportunities and emerge as winners. Those firms will have well-defined visions of future capabilities and champions of change to bring that vision to fruition.