Analysis

Sustainable Standpoint: It’s time for ESG to grow up

ESG Clarity Committee members share their reflections and predictions in part three of this series

Sustainable Standpoint is a new ESG Clarity series focusing on reflections of developments in ESG investing over the past year, and predictions for potential milestones in 2023.

In part three of this series, Louisiana Salge, Matt Crossman, Anna Mercer and Annabel Brodie-Smith, share their thoughts on the outcomes of COP27 and COP15, the energy crisis and fund labelling.

The two COPs have disappointed

Louisiana Salge, senior sustainability specialist, EQ Investors

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

The war in Ukraine, and the intensifying cost of living and energy crisis are amongst the biggest humanitarian issues we have faced in a decade. Investors have been affected by these too, and in turn it is our responsibility to help alleviate these where we can. For example, ShareAction’s living wage investor engagement group is focusing on zero-hour contracts and improving workforce policies to provide greater security in a world of rising living costs.

The two COPs – one on climate and one on biodiversity – have largely disappointed. COP27 did not result in any new breakthrough agreements and we are increasingly worried about the performative nature of these gatherings, and the role of the biggest polluters in lobbying for keeping ‘business as usual’ on the table for longer.

Please provide one prediction for the ESG investment world for 2023. 

Client demand for investing in line with sustainable outcomes is far greater than what is currently met. We are excited the regulator in Europe and the UK is putting a focus on greenwashing and aiming to enhance transparency, with many changes coming into play in 2023.

While we remain cautious about the macroeconomic outlook for 2023, the past year has shown that in times of stress, the sustainable investment industry showed itself to be as innovative as ever, bringing new products and solutions to the market. We anticipate a lot more innovation in the next year.

Paris Agreement is still alive…just

Matt Crossman, stewardship director, Rathbone

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

Sitting at my desk in January 2021, I thought implementing the net-zero commitment would be our biggest challenge ahead. Then the first truly global energy crisis got underwayand accelerated and deepened beyond recognition with the horrifying invasion of Ukraine. The fossil fuel industry wasted no time in boosting the credentials of ‘fuels with no future’ in a Paris-Aligned world, even as ESG itself faced a backlash in the US. But the science hasn’t changed, nor has the pathway to a more sustainable future – perseverance in this is vital and this ultimate goal is not completely out of our reach.

We will continue to focus on the core problem and seek win/win solutions. The onset of winter has showed us that consumers can be engaged to reduce energy demand, and the International Energy Agency has revised its five-year renewables forecast upwards by 30%, with clean technologies set to be the biggest source of energy generation by 2027. Contrary to some reports, the 1.5 degree target from the Paris Agreement is still alive, although just barely. Perhaps we will look back at 2022 as the moment the energy transition went to warp speed.

Please provide one prediction for the ESG investment world for 2023. 

Having recently returned from the first PRI in Person event to take place in last three years, it was noticeable to me that there seemed to be a huge appetite among the delegates present for a re-engagement with the core value of taking a more responsible approach to investing. As the investment industry receives scrutiny from a number of different areas, but also much needed and welcome challenge from regulators, I can see a path emerging for a reformed, re-invigorated investment paradigm in 2023.

I think this refreshed approach could see greater transparency, clearer definitions of terms for investors and a more aligned language and action across the industry and sectors. Clarity, understanding and by extension, greater trust in the products and services available to investors can drive the momentum towards the sustainable future which is so crucial. It’s important for those in the financial systems to seek to influence that path towards more sustainable outcomes for all stakeholders – as the head of the ISSB reminded the PRI conference, you aren’t sat in traffic, you are the traffic!

Questions remain over parameters of SDR

Anna Mercer, head of 3D research, Square Mile Investment Consulting and Research

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it? 

The field of responsible investment continues to evolve and with it the regulatory oversight governing it to ensure that its promise of delivering tangible benefits to society and the environment is met. To help advisers help their clients make informed investment decisions we will continue to analyse incoming regulation, reassess definitions describing this approach to investment and to express our interpretations in a transparent and accessible way.

This is a challenge faced by all areas of asset management, from fund groups to industry bodies and is one which we embrace as a fundamental duty. The latest SDR proposals announced in late October shows that this challenge will continue into 2023, and we will seek to maintain our approach of constructive engagement with the FCA, the industry and our clients with the aim of introducing clarity where there might be confusion.

Please provide one prediction for the ESG investment world for 2023.

Responsible investment funds have had a difficult run in 2022 in performance terms. This has led those with a more sceptical view towards this approach to investment to question the durability of their popularity. However, we firmly believe that demand for responsible investment funds will persist. The short-term headwinds that have negatively impacted their performance this year, however, do not fundamentally impede the long-term secular trends that should hopefully see capital flows favour businesses that are part of the transition towards a more sustainable future.

Financial performance is an important consideration for investors in responsible investment funds, but of equal importance is the knowledge that their money is being put to work in a way that benefits the environment and/or society. The loose and sometimes confusing terminology applied to responsible investment by funds groups and the broader industry has been a further critique levied by naysayers who are quick to point to instances of greenwashing or misleading promises.

SDR, with its proposed labelling regime, aims to address this by splitting the universe of responsible investment funds into three categories: ‘sustainable focus’, ‘sustainable improvers’ and ‘sustainable impact’. Questions remain over the precise parameters of these categorisations and the FCA’s consultation remains open. However, the move towards greater transparency and the regulator’s focus on the need to be clear, fair and not misleading, which will continue to play out in 2023. This should hopefully enhance investors’ ability to see that their savings are being employed as a force for good and that their chosen funds invest in the way they have defined in their objectives.

No more KID-ding investors

Annabel Brodie-Smith, communications director, Association of Investment Companies

Reflecting on what has been a tumultuous year for ESG and markets in general, what has been your biggest challenge and how have you overcome it?

It’s rare the whole financial services community is united in their criticism but that’s exactly what happened with Key Information Documents (KIDs). These dangerous disclosures have been the investment company industry’s key concern for the past five years.

From January 2018 when KIDs were introduced, KIDs were dangerous and misleading for consumers as the future performance scenarios within the disclosures were based on past performance – we all know that’s nonsense. The risk indicators were highly unreliable too, with a methodology that led to VCTs receiving some of the lowest risk ratings – clearly bonkers! And that’s before we get on to the fact that open-ended funds had a completely incomparable (but very similar sounding) disclosure called the Key Investor Information Document (KIID).

At long last the investment company industry can breathe a collective sigh of relief. Our relentless lobbying, including the publication of a paper explaining the dangers of KIDs, Burn before reading, has paid off. In the recent Edinburgh reforms, the Treasury has proposed the abolition of the PRIIPs Regulation which introduced KIDs.

This issue has been about the governance part of ESG. We were inundated by complaints from investment company directors that a regulator is forcing them to overstate their performance and understate their risks. The independent boards of directors are clear they want to present a fair picture rather than complying with misguided rules. At long last those rules will be changed and there will be no more KID-ding investors.

Please provide one prediction for the ESG investment world for 2023.

My prediction is this will be the year that ESG investment begins to mature. The FCA’s fund labelling regime and the planned regulation of ESG ratings providers beckons. It will no longer be enough to talk a good game on ESG and sound convincing. Investors want proof and to see impact measurements versus a benchmark, which are tracked over time. Inspiring stories and examples are also important. Woolly unsubstantiated statements and vague claims are not good enough.

The publication of FCA’s consultation paper has made it clearer how the regulator will impose some order and consistency on ESG. The old world where any old fund could label itself sustainable or green is fast disappearing. Our research shows this action is very much necessary. Only 1% of advisers and wealth managers completely trust sustainability claims from funds – whereas 58% of private investors are not convinced by ESG claims from funds, up sharply from 48% last year. It’s clearly time for ESG to grow up.

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Natalie Kenway

Natalie is global head of ESG insight for ESG Clarity and has been an investment journalist for 16 years. She won Editor of the Year at the Aviva Investors Sustainability Media Awards 2021, and was Winner...