The opportunity for ESG funds in 2021

ESG worldThe story of ESG began in 2004 with Kofi Annan writing to CEOs, says Philip Graham of law firm Harneys. It’s been a long journey - but regulatory measures ensure that ESG is for European fund managers here to stay.

Ignoring an awful lot of the current newsreels in the US right now, there is absolutely no doubt that recent victories by the Democrat candidates Jon Ossoff and the Rev. Raphael Warnock in Georgia have added to the political transformation we will see in 2021 and will ensure that President Joe Biden will certainly have an easier time enacting his agenda.

Whilst there is clearly a cacophony of different issues for him to tackle, it did remind me of this excellent article in Reuters back in October which was already tracking the moves being made in the investment funds industry to continue the meteoric rise of ESG investment strategies. 

For those that are very late to the party, ESG stands for environmental, social and governance and the story of ESG investing actually began back in January 2004 when former UN Secretary General Kofi Annan wrote to over 50 CEOs of major financial institutions, inviting them to participate in a joint initiative under the auspices of the UN Global Compact and with the support of the International Finance Corporation (IFC) and the Swiss Government. The goal of the initiative was to find ways to integrate ESG into capital markets. 

Whilst the concept has become an undoubted success, getting it to this position has not been without challenges. Ignoring those that thought ESG might just be something of a fad, one of the more interesting issues came from institutional investors who argued that making investment decisions on the basis of these principles was actually a breach of their fiduciary duties to their shareholder base.

This has caused extensive debate, but a strong argument was being made in many circles that the pursuit of financial gains should always be the sole focus. It became litigious in a number of jurisdictions, where investment managers were challenged on both their principles and ethics, although in almost every case, it was where the financial gains had not matched the expectations of the investors. 

But both the UK and the EU decided to take this out of the hands of the courts and the new disclosure requirements for investment managers and advisers with respect to their ESG policies will apply in the European Union from 10 March 2021 and new climate-related disclosures will apply to investment managers under a UK disclosures regime that is expected to be phased in from 2022.

We will ignore the impact of Brexit for the purposes of this short article, but it does appear that all of Europe is united on this front. What is interesting to watch is that the regulatory landscape in this area is undoubtedly evolving and when you add these new initiatives to the Shareholder Rights Directive, the UK Stewardship Code, the Principles for Responsible Investing and the UK Corporate Governance Code, it is now the case that European managers will be operating within these parameters indefinitely. 

Figures show that assets in sustainable investment products in Europe are forecast to reach €7.6 trillion over the next five years, which will then outnumber conventional funds. Part of this drives comes from a critical mass of pension funds and insurers deploying capital exclusively to asset managers with ESG capabilities.

Whilst this level of market dominance has not yet been reached in the US, largely due to some of the scepticism highlighted above, the clearer path that the Democratic party now have in the US may well see their domestic capital providers follow a very similar path, especially in a market with greater maturity that really is looking for a transformation for the better.

* Philip Graham is global head of investment funds at law firm Harneys.

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