Environmental, Social and Governance (ESG) investing is growing at an unprecedented rate, with current demand for ESG products far exceeding supply. PwC expects ESG assets under management in the US alone to more than double, from $4.5 trillion in 2021 to $10.5 trillion in 2026, with the Inflation Reduction Act (IRA) channeling $390 billion into the fight against climate change.

In Europe, the Sustainable Finance Disclosure Regulation (SFDR) has crystalised a view among market participants that transparency is key when it comes to understanding the impacts of investment decisions on society and the environment. New regulations aim to increase accountability and disclosure on ESG matters to combat greenwashing (overstating the “greenness” of a product) and help investors make more informed investment decisions.

Despite the growing consensus that the world needs to move towards a more sustainable economic model, criticism of ESG has been on the rise. A so-called anti-ESG movement has been grabbing headlines. In the US, it has reached the upper echelons of the political process, with some state legislatures introducing “anti-ESG” laws. Kentucky, for example, introduced laws prohibiting state bodies from using investment firms which boycott fossil fuel companies. By ‘boycotting’ they mean financial institutions limiting their exposure to fossil fuel companies because of their role in the climate crisis.

All criticism is not the same. Some is misguided or downright wrong, while some can highlight areas where improvement and change are needed. A mixed of all three can be found when it comes to ESG.

The Complexity of ESG 

Defining ESG can pose a few challenges and therein lies the source of some criticism. Definitions of what is considered ESG can be highly subjective, as the urgency and drive to address an ESG issue will vary from person to person. In other words, what is good ESG to Peter may not seem so in the eyes of Paul.

ESG and sustainability, two closely interlinked but distinct concepts, need to be distinguished. ESG is a term used in investing that sets specific criteria for assessing how investee companies are addressing environmental (E) and social (S) risks and opportunities, as well as the company’s ability to manage these issues (G). Company policies, procedures, labour management and board ownership of these risks are some of the metrics used in ESG.  

Sustainability, on the other hand, is much broader and describes our ability to maintain a balance of healthy environmental, social, and economic systems. No solution can be sustainable unless it fulfils these three pillars. The UN Sustainable Development Goals (SDGs) show how sustainability is achieved; we can’t address one goal without considering all the others, e.g., we can’t address the climate crisis without addressing inequality, poverty, education and so on. Both sustainability and ESG deal with complex issues that require multiple stakeholders to look at problems and solutions systematically.  

Not all ESG products are the same. While some may seek to address the SDGs in general, others may focus on particular themes like the environment without considering social issues in the same way. Some ESG products may focus entirely on ESG financial risks and/or limiting the worst impacts on sustainability (e.g. human rights violations). Whatever the approach, ESG products are required to provide clear guidelines to investors as to how ESG is defined, monitored, and measured. 

To help investors navigate the complexity of ESG investing and how it addresses sustainability issues, regulation is now making clients’ sustainability preferences an integral part of suitability assessment. This ensures clients are offered products that not only align with their investment objectives and personal circumstances, but also with any preferences they may have when it comes to understanding the impact their investments have in the world. Remember, sustainability is the environmental, social, and economic challenges we face in securing our coexistence on this planet, while ESG is the investment strategy that allows criteria to be defined to achieve these objectives.

Another source of criticism is the ESG data issued by companies, as reporting is currently unstandardised, making data difficult to compare. This, too, is being addressed through regulation, though at a slower pace than the SFDR. This mismatch in timing has made the implementation of SFDR more challenging as better quality ESG data is lacking. 

When it comes to ESG, disclosure is paramount, and it must start somewhere. It has started with financial services providers in their role as facilitators between investors and entities looking for funding.  At Cantor Fitzgerald, we are working to implement these regulatory changes to ensure our clients have a seamless experience navigating the intricacies of ESG investing.