The ESG (R)evolution
The Covid pandemic and the shortcomings of the global financial system have stressed the need to shift from short-term investment approaches to long-term, sustainable ones. Positive environmental, social, and governance standards appear to determine a company’s ability to cope with the crisis. Moreover, the pandemic has made us all more aware of a range of other high-impact outcomes which, unlike this pandemic, were always highly probable. In this context, many have praised ESG investing for incorporating environmental, social and governance factors into asset allocation and risk decisions. Despite being around for 30 years, ESG investments have gained tremendous popularity in the past five years. ESG-themed assets have taken by storm the financial sector, and public regulations are trying to catch up. The ESG revolution is underway.
Over the last few years, the sector has experienced a massive inflow of capital, from $22.8 trillion in 2016 to $40.5 trillion in 2020. At this rate, global ESG-themed AUM may hit $53 trillion by 2025, representing more than a third of the $140.5 trillion in projected total AUM worldwide. Developing countries are also affected by this movement, where foreign investments drive the demand for ESG reporting despite being a niche sector of the market. As this unfolds, the ESG ecosystem keeps on growing and currently has more than 600 different ESG rankings and ratings, and 4,500 ESG KPI. ESG approaches are quickly gaining ground among asset managers who are now participating in collective initiatives, developing their own ESG strategies and actively engaging with the companies in their portfolios. In 2020, BlackRock announced that all of its almost $7trillion AUM would be governed by ESG considerations. In December of the same year, the Net Zero Asset Managers Initiative was launched, including 30 of the world’s biggest asset managers – about $9 trillion AUM – committing to achieve net zero carbon emissions across their portfolios by 2050.
The regulatory landscape is also evolving at a fast pace. In the European Union, the recently implemented Sustainable Finance Disclosure Regulations require firms to provide information about the ESG risks in their clients’ portfolios. Products also have to be classified into one of three categories, all linked to additional disclosure requirements. In the US, the attention of the Security and Exchange Commission (SEC) has only recently shifted to the topic, with the announcement in March of the creation of a taskforce dedicated to exploring measures to standardise and enforce ESG disclosure frameworks and reporting.
Beyond a temporary trend, ESG seems closer to a financial revolution that aligns with the challenges and values of its time. Recent globalised movements for racial justice and climate action have called for the restructuring of our entire economic system. Led by millennials, this movement is felt throughout the financial sector as a number of ESG-motivated and ESG-aware investors also happen to be born between 1981 and 1996. In 2018, already 88% of high-net worth millennials were actively reviewing the ESG impact of their investment holdings. Similarly, in 2019 an Allianz study found out that 89% of millennials expected their financial intermediaries to take into account ESG factors and issues before recommending an investment opportunity. These numbers are even more significant knowing that millennials account for over a third of the global population and are in the process of undergoing a massive $30 trillion intergenerational wealth transfer, from baby boomers to their children. This growing trend among millennials shows the importance that ESG investments will have in the future.
However, many barriers may discourage investors from adopting ESG considerations. Data, among other things, may be the biggest challenge asset managers are facing now. The absence of a standardised framework, diverging opinions on materiality and inconsistent terminologies have created a big melting pot where no one speaks the same language. In this situation, collecting and interpreting ESG data can be complex, time-consuming and therefore discouraging. It is still too early to tell whether the global regulations currently underway will put an end to the problem, but it is a step in the right direction.
The fragility of the global financial system, the generational push for a new economic paradigm with environmental and social concerns at its core, and the development of regulations around the world to sustain this transition are pushing the ESG (r)evolution.
In this new era, the challenges of yesterday have become the opportunities of tomorrow. However, whether we will be able to fully benefit from these opportunities will very probably depend on the capacity of global stakeholders to agree on a standardised ESG disclosure framework and taxonomy.
 Bank of America (2018). Insights on Wealth and Worth
 Allianz (2019). ESG Investor Sentiment Study