By: Lyons O’Keeffe, ESG Director at IQ-EQ
Environmental, social and governance (ESG) considerations and other social responsibility concerns will continue their growing influence in 2023. The ‘great generational wealth transfer’ will see significant assets passed from baby boomers to younger investor classes who prioritize their personal values as they make investment decisions – which will only continue the growth of ESG this year.
The one-year growth rate of ESG fund launches in the US is more than twice that of funds without ESG criteria – 80% versus 34%, respectively – and Dow Jones reported that ESG investments are projected to more than double in the next three years. Evidence is emerging that a better ESG score translates to lower cost of capital, because the risks that affect business are reduced with a strong ESG proposition. With ESG now a permanent part of our capital markets ecosystem, key questions remain: How will corporations and institutions deliver on the sustainability requirements of investors, regulators and consumers? How will the Securities and Exchange Commission’s (SEC) intensified ESG scrutiny impact the ESG asset management industry?
The SEC is watching and the scrutiny is impacting behavior
In 2022, the SEC recovered an all-time record of $6.4B in penalties on behalf of investors, a growing percentage of which is a result of its newly established Climate and ESG Task Force. The task force dinged major institutions with fines as high as $12M for disclosure deficiencies. In 2023, regulatory scrutiny into funds’ aims, names and stated impact will intensify in order to direct capital more effectively toward sustainable 2050 targets and to curb greenwashing and over-promising.
The SEC’s crackdown has resulted in a precipitous decline in what is being claimed to be sustainable. We are seeing changes in names and labels as funds downgrade their ambitions or find they are unable to source data to back up their claims. This year, we can expect regulations and enforcement to make greenwashing more ‘obvious’ and accordingly harder to get away with.
Impact investing: translating personal values to social value
In 2022, 79% of surveyed C-suite leaders said their company has a clear and defined purpose strategy that is integrated with core business strategy. However, 22% of the same surveyed leaders indicated that their company does not make it a priority to collect and report on purpose related data. With the difference between ESG talk and action now under a microscope, we can also expect a greater focus on impact investing this year.
While ESG investing appraises a company’s ESG risks and opportunities for the purpose of generating financial returns, impact investing directly seeks a concrete result on a specific goal that benefits a social good. This more goal orientated investment philosophy will suit younger investors wanting more active, personalized ownership. Institutions and wealth advisors will need greater engagement with these investors who will want to better understand the impacts associated with their portfolios. They will be demanding alignment with their personal values that are linked towards a more sustainable future.
Greater reference to natural capital and biodiversity
At COP15 in 2022, 200 countries adopted a new Global Biodiversity Framework, including four overarching goals to protect nature, with concrete measures to halt nature loss. In 2023, investment decisions will increasingly focus on portfolios that preserve natural capital and even factor in costs for its use, such as seen with carbon pricing. Natural capital refers to the planet’s stock of natural resources such as water, soil, fish and energy, which we depend on to run our world. As an enormous amount of natural capital value is being lost each year, investors will increasingly quantify natural capital and biodiversity risks in their portfolios by identifying companies with operations in ecologically sensitive areas or with exposure to high levels of natural capital consumption. Indeed, voluntary carbon markets, by which emitters offset their unavoidable emissions by purchasing carbon credits, may hold benefits as some carbon credits are generated via nature-based solutions such as afforestation.
Technology is essential to help resolve the ESG data challenge
Investors and institutions will increasingly leverage data intelligence to evaluate ESG investments, measure ESG impact and make investment decisions. The task is daunting, often a data creation challenge rather than a data collecting challenge. And not having strict standardized criteria for what constitutes an ESG investment doesn’t help. Companies should lean on new bespoke platforms to help with data management and intelligent guidance, while delivering large pools of consistent data to compare performance. With more data at play this year, there is more scope for fund managers to understand, manage and influence the ESG performance of their portfolio and ultimately report on it.
PwC projects that around one fifth of all assets under management (AUM) could be ESG-orientated by 2026. Greater regulatory scrutiny is forcing a market correction and reassessment in which the industry must better define what ESG is and measure its impact, to ensure they can fully substantiate their sustainability claims.
Lyons O’Keeffe is a ESG Director at IQ-EQ based in United Kingdom.