Environmental, social and governance (ESG) investing has moved from a remote corner of the investment horizon into the mainstream. Yet for all its progress, the sector faces critical challenges, notes consultant Agnes Sipiczki in this informative essay on the European ESG experience. She analyzes the problems of information asymmetry, high fees, and a lack of transparency and comparative data, and she calls for professional investors and regulators to take the lead in developing and maintaining a global set of standards that will allow the sector to grow.
- Environmental, social and governance (ESG) investments have become a significant asset class in Europe.
- The ESG sector is experiencing growing pains.
- Policy initiatives to increase disclosure rules and develop standards will aid the sector’s growth.
Environmental, social and governance (ESG) investments have become a significant asset class in Europe.
The number of European ESG funds grew markedly between 2020 and 2021, and assets under management had inched over the threshold of €100 billion (approximately $107 billion) at the end of 2020 and kept climbing. Recent research shows that the returns from these investments meet or exceed those from traditional assets, so investor interest in sustainable business models is increasing.
“Overall, recent trends in the ESG market indicate that there is no evident trade-off between sustainable investing and financial performance, and there is a growing appetite in the private sector for supporting sustainable and resilient business models by accounting for the interests of various stakeholders.”
The European Union’s 2030 environmental objectives call for nearly half a trillion more euros of green investment annually. The private sector is critical to meeting these financing goals, as investors’ capital allocation decisions can pressure businesses to meet sustainability criteria.
The ESG sector is experiencing growing pains.
Yet serious challenges accompany the growth of ESG. Investors and financial managers need reliable data for decision making, but some third-party ESG appraisal firms use questionable rating criteria. Inconsistent ESG disclosure and terminology hinder an effective comparison of industry ratings, which lack standard regulatory definitions; are subject to biases of firm size, location and industry; and are often informed by unstructured, self-reported company disclosures.
“Due to inconsistencies between the methodologies and metrics used by rating agencies and consultancies, their ratings tell very different stories about companies’ sustainability credentials.”
Investors risk buying into opportunities from asset managers who are “greenwashing” – the practice of questionable adherence to sound principles of ESG investment – their offerings. A lack of comparable data translates into greater opacity, which could lead to capital misallocation that impedes green objectives.
Policy initiatives to increase disclosure rules and develop standards will aid the sector’s growth.
The European Commission’s recommendations recognize the inconsistencies and problems within the burgeoning ESG market. Regulation of the ESG taxonomy needs to be extensive, capturing all aspects of the environmental, social and governance pieces. A common set of indicators and processes to measure them is essential. Sustainability reporting standards for nonfinancial data require consistency and should eventually aspire to a single set of criteria. Third-party oversight and disciplinary tools will be necessary. ESG rating agencies should be subject to rules on transparency, regulatory oversight and conflicts of interest.
“The Taxonomy Regulation should be based on science-based criteria, be applied exhaustively, and cover all social and governance components, rather than only looking at the (crucial) environmental dimension.”
Authorities also should educate investors and the public about ESG, including ways in which stakeholders can hold corporations accountable for their sustainability commitments.
About the Author
Agnes Sipiczki is a former CEPS research assistant and presently a consultant at FTI Consulting.