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ESG under fire?

As we step into 2024, the world of sustainable investing continues to evolve. The term Environmental, Social, and Governance (ESG) is turning 20 years old and is being met with mixed emotions.  

Despite growing in popularity at the start of this decade – as for any boom, a day of reckoning was inevitable – ESG faces challenges and scepticism. This is particularly true in how it has impacted carbon emissions (witness the relentless increase in parts per million carbon in the atmosphere), its political backlash in the US (with the notion that returns should always be the primary focus for fiduciaries) and the trade-offs we are sometimes forced to choose. For example, unethically-sourced materials for batteries vs poorly governed tech companies. Adding return to this means these will never, or very rarely, be all wins.  

Therefore, the challenges have even gone as far as people asking “is ESG dying?” I do not take that extreme view but believe that responsible investment is maturing and evolving instead and remains important for a more sustainable second half of this century.

So, despite these challenges, ESG remains a critical tool in the investor's arsenal, albeit one that requires careful management.

The rise of natural capital and regulatory changes

One promising development in responsible investing is the emergence of natural capital. Simply, this combines responses to climate change with broader ecological considerations. While the COP28 summit did not yield binding, enforceable emissions targets (and indeed it could not have done this), it marked some progress.

Emissions from fossil fuels causing climate change have been compared to cigarettes causing death: the science is clear. And for the first time at a COP, fossil-fuel based energy systems were discussed with some intention for action to ‘transition away’ instead of ‘phase out’. Accompanying this outcome from COP28 for natural capital, in 2023, because of the launch of a new disclosure framework and investor stewardship collaboration, nature is being measured and assessed for the first meaningful time.  

And regulatory changes are bringing much-needed structure and rigour. These include:

1. Consumer-focused labelling: new regulations to enhance transparency, allowing consumers to make more informed decisions based on sustainability criteria and maybe help with the trade-offs just mentioned.

2. Combatting misleading sustainability claims: the FCA is cracking down on greenwashing and misleading statements, ensuring that claims about sustainability are accurate, complete and substantiated.

3. ESG data providers: enhanced oversight of ESG data providers will ensure the reliability and integrity of the information used in responsible investing, up to selecting which assets make it into a fund labelled as green.

Stewardship: one element to future success

Central to the evolution of responsible investing is the concept of stewardship. Engaging in meaningful dialogue about sustainability is a core fiduciary duty. If the value of any investment is its future cash flows discounted back to today, and these cash flows can go up or down because of sustainability opportunity or risk, isn’t it crucial for active investors to understand and then manage these impacts? This involves not just assessing current practices but also influencing behaviour towards more sustainable and responsible models through partnership and collaboration, without forgetting – for listed equity – the rights we have to vote against directors or to propose shareholder resolutions.

Conclusion

As we navigate through 2024, the outlook for sustainable investing is cautious. The integration of core sustainability concepts into broader investment, corporate, and geopolitical activities signals maturing. While challenges remain, the developments in natural capital focus, regulatory changes and enhanced stewardship practices provide a solid foundation for responsible investment to thrive.

Find out more about our approach to responsible investment