The Year ESG Grew Up

“A litmus test”; “a turning point”; “a watershed moment”: 2020 has been credited as a milestone year for environmental, social and governance (ESG) investing. Where does that leave your business? 

Born in a bull market

The first global recession in over a decade was always going to be a big moment. While permutations of ‘responsible investing’ have existed for as long as asset management itself, the concept of ESG investing is new. It had yet to face a real hurdle. 

The term was only coined in 2005. One year later, the United Nations launched the six Principles for Responsible Investment: “a voluntary and aspirational set of investment principles that offer a menu of possible actions for incorporating ESG issues into investment practice.” This was closely followed by the global financial crisis, which served as a painful but necessary reminder that markets don’t always work in the best interests of societies and economies.

Investors and regulators emerged with a renewed focus on long-term stewardship and good corporate governance—and so ESG integration began its exponential ascent. 

The trend hit a fever pitch in 2019, when flows into ESG funds quadrupled from 2018. By this point, the PRI had burgeoned into a network of over 1,700 international investors representing over $70 trillion. A proliferation of national mandates and disclosure regulations, such as the European Commission’s sustainability disclosure rules, had propelled ESG into the mainstream. 

From virtue- to value-signalling

Even at the beginning of last year, however, scepticism remained. After all, ESG was the product of a healthy market. In a downturn, would portfolio managers adhere to their commitments? Would end-investors still plough money into sustainable funds? And would companies—having talked loudly about putting purpose on par with profit in the good times—continue to prioritise ESG issues in the bad?

If COVID-19 recession put stakeholder capitalism to the test, it hasn’t just passed: it has excelled. 

There are four critical things to take away from the year. 

First, the tinderbox itself: COVID-19. The pandemic created more interest in ESG generally, as the world woke up to the fact that the most urgent environmental and social challenges won’t be solved by policy alone. Social factors, such as business ethics and treatment of labour forces, have come under particular scrutiny.

Second, flows into sustainable funds continued to grow. Morningstar data show that assets in sustainable funds hit a record high of $1.2 trillion in Q3, with Europe alone surpassing the $1 trillion mark for the first time. Funds with an ESG tilt attracted positive headlines for outperforming their traditional peers in almost every month. 

Third, investor activity intensified. 2020 began with BlackRock, the world’s largest asset manager, pledging to put sustainability at the heart of its global investment strategy; it ended with the launch of the Net Zero Asset Managers Initiative. Product development has remained high, with the launch of hundreds of new sustainable funds. 

Finally, policymakers and standard setters made strides. Yielding to the need for simplified corporate sustainability reporting, the Sustainability Accounting Standards Board and International Integrated Reporting Council merged. The EU introduced mandatory ESG reporting requirements, while a Biden administration promises similar progress in the US. 

Don’t be left behind 

ESG has never been a hotter topic, but the subject of the conversation is about to change. ESG factors are finally being addressed in their entirety. Policy, in Europe at least, is approaching maturity. The sustainable fund market is reaching a saturation point, and, as millennial investors begin to carve out the market, demand will only continue to increase.

As the steady growth of new funds starts to plateau, we expect the focus in capital markets to shift away from investment innovation and towards corporate activity. Businesses, particularly those raising capital, would do well to pay attention. Those that don’t measure their non-financial performance with the same rigour as their financial performance will soon be left behind.

Are you doing enough to meet the expectations of investors, regulators and consumers in 2021?