5 important ESG developments that will carry into 2023
By Dan Mistler; Marie Luchet, ACA Group
Published: 20 March 2023
At first blush, some might have regarded 2022 as the year of ‘ESG backlash’. But that’s only based on the headlines.
On the ground, investors continued to methodically press ahead on the environmental, social, and governance (ESG) front, further incorporating ESG factors into their existing investment frameworks. A Pitchbook survey of general partners (GPs), limited partners (LPs), and other investors found that 62% now fully or partially integrate sustainable investment principles throughout their portfolios, up from 58% in 2021. This has resulted in unprecedented demand for ESG data to help monitor, measure, and benchmark ESG performance over time and against stated ESG claims. Spending on ESG data and analytics, for example, was expected to exceed US$1.3 billion in 2022, up from US$1 billion the prior year. Overall spending on ESG business services is expected to grow 32% a year for the next five years. Another driver of this growth is the fact that ESG has become an area of increasing focus for regulators—not for political reasons, but to root out greenwashing in a strategy that continues to grow in popularity and assets, irrespective of the backlash talk.
The heightened regulatory scrutiny of ESG is likely to continue this year, as are several other trends.
Here are 5 key ESG trends that unfolded in 2022 which are expected to continue to be big themes in 2023.
The arms race for high quality data heats up
From increasing regulatory scrutiny to greater investor demand for accurate monitoring and measurement, the need for ESG data continues to expand. This goes beyond basic ESG scoring. Investors are demanding higher-quality data and analytics to help them track and benchmark ESG performance over time. In fact, a recent EY survey of institutional investors found that around half of asset managers are concerned about the lack of real-time and forward-looking ESG reporting.
The challenge for the industry is to improve the breadth and quality of the data that’s available to them. This is particularly true in the private markets, where investors are seeking quality data for privately held companies when very little information is publicly known. We expect this demand to grow further in 2023. In particular, in Europe the main objective of the new Corporate Sustainability Reporting Directive (CSRD), previously known as the Non-Financial Reporting Directive (NFRD), approved by the European Parliament in November 2022 and coming into effect in 2024, is to increase ESG data quality and comparability.
Biodiversity becomes a front-burner issue
One area where data demand is expected to grow is around biodiversity. While climate issues in general have been a leading area of focus among ESG investors for years, biodiversity, which is a subset of that theme, began to pick up steam in 2022. In fact 41% of investors say that biodiversity, which speaks to the variety of species within an ecosystem and the resulting strength of those habitats, is a “significant factor” in their investment policy today. That’s up from just 19% two years ago. And over the next two years, that figure is expected to climb to 56%, according to Robeco’s 2022 Global Climate Survey.
This focus on biodiversity is being driven by investor interest. More than half of investors surveyed cite their commitment to “reducing long-term systemic risks associated with biodiversity loss impacting all sectors, societies, and economies”. In other words, because biodiversity, which is directly affected by climate issues, impacts communities and economies on critical issues like clean water, food, and energy, it is where the “E” in ESG (environment) meets the “S” (or social impact). At the same time, as regulators and investors seek greater transparency on ESG performance and impacts, the need to monitor and measure how company operations and investment decisions affect local communities and ecosystems is only growing.
It is also worth noting the historic deal to stop the destruction of biodiversity at COP15 in December, 2022. This deal includes targets to protect 30% of the planet for nature by the end of the decade, reform US$500bn (£410bn) of environmentally damaging subsidies, and restore 30% of the planet’s degraded terrestrial, inland water, coastal and marine ecosystems.
ESG enforcement at the SEC picks up steam
There was a clear theme in US Securities and Exchange Commission (SEC) enforcements actions in 2022 - if you say or imply what you do, you have to do what you say. In November, the agency charged a prominent asset manager for policies and procedures failures involving two mutual funds and one separately managed account strategy marketed as ESG investments. This came a few months after the SEC charged another large investment adviser for implying that all investments in certain funds had undergone ESG review though this was not always the case. And a few months prior to that, the SEC charged a robo-advisor for misleading statements implying that its advisory services were compliant with Islamic Shari’ah law, though written procedures were not in place to ensure compliance with the claims.
Investors can expect this push to continue, as the SEC announced this year that among its Division of Examinations’ priorities is ESG. This includes ensuring that firms are operating in a manner that aligns with their ESG disclosures, ESG products are appropriately labeled, and ESG-related recommendations are made in the best interest of investors.
Regulators propose a ‘bigger stick’ approach to greenwashing
In recent years, Europe had taken the lead in pushing for a regulatory approach to combat greenwashing, through efforts such as the EU’s Sustainable Finance Disclosure Regulation (SFDR), the NFRD (soon to be CSRD), and EU Taxonomy. This year was the SEC and the UK’s Financial Conduct Authority’s (FCA) turn.
In March, the SEC proposed amendments to existing rules requiring additional climate related disclosures for publicly traded companies. The SEC also proposed enhanced disclosures by investment advisers and investment companies on ESG practices, along with rules changes to prevent misleading or deceptive naming of funds that don’t invest 80% or more of their assets in securities that match the terminology. The SEC’s proposals are not politically based, but instead reflect best practices so firms live up to their advertised and stated ESG claims.
In August the FCA also warned that it will scrutinise ESG claims made by hedge funds and private equity firms as part of its annual supervisory priorities ensuring that marketing materials accurately describe their product.
The FCA has also published its proposal for clamping down on greenwashing across all sustainably labelled products - CP22/20: Sustainability Disclosure Requirements (SDR). The proposal aims to build transparency and trust by introducing labels to help consumers navigate the market for sustainable investment products and ensure that sustainability-related terms in the naming and marketing of products are proportionate to the sustainability profile of the product.
Economic realities bite
A new wrinkle presented itself in the ESG discussion in 2022: the global economic downturn, which is affecting virtually every asset class and making it harder to prioritise ESG goals as the overall business climate weakens. The challenge for investors in this environment is to continue to push forward against these geo-political headwinds. For some, the answer is simply ignoring the headlines and sticking with their long-term plans. For others, it may be finding alternative solutions that are lower-cost and more efficient to achieve their longer-term ESG needs.
The ESG landscape is evolving at a rapid pace and requires additional resources to meet investor and regulatory expectations. Firms would be prudent to consider their regulatory and investor requirements and determine if any changes need to be made to their ESG program to meet this increased scrutiny.