The Market for Sustainable Investment
The financial services industry has taken notice of importance of sustainable finance and the market for sustainable investment opportunities has been growing steadily as more and more industry participants are recognizing the long-term benefits of a more sustainable economy and incorporating sustainability considerations into their strategies and operations. ?According to data from the GSIA, global investment in sustainable assets (assets under management, or “AUM”) stood at USD 30 trillion in 2022.[1] ?That number reflected a material change in the methodology used in the US to determine sustainable investment AUM that reduced the amount from USD 17 trillion reported for the US in 2020 to USD 8.4 trillion.[2]? Inclusion of the US data would result in a global decline in investment activity of 14% from 2020; however, in non-US markets (Europe, Canada, Japan, Australia and New Zealand), sustainable investment AUM increased by 20% to USD21.9 trillion since 2020.? The absolute value of sustainable investing assets grew across most regions (Europe, Australia and New Zealand and Japan), a reflection of broader market growth.? The proportion of sustainable investing relative to total AUM grew in Australia and New Zealand and Japan; however, that metric declined in Europe from 42% to 38%, perhaps reflecting increased regulatory requirements and a subsequent move to more conservative fund labelling and reporting, all part of list of actions included in the EU’s Sustainable Finance Action Plan.[3]
Globally, the largest sustainable investment strategy was corporate engagement and shareholder action (USD 8.06 trillion), followed by ESG integration (USD 5.59 trillion), an interesting evolution from 2018 when negative/exclusionary screen was the most popular through 2020 when ESG integration was the most popular.? The GSIA cautioned that changes in reporting methodology made comparison across reporting periods problematic, but pointed out that the emergence of engagement and activism in the data was “in line with the experience of practitioners who indicated that investors are increasingly focused on engagement with the aim of influencing change both within the companies they own and in the real economy”.? The top three sustainable investment strategies (corporate engagement and shareholder activism, ESG integration and negative/exclusionary screening) consistently accounted for over 80% of the assets across each region, however there are differences in the preference for each strategy across regions and it was notable to see the shift in the US away from ESG integration (15%) towards corporate engagement and shareholder action (62%).[4]
Another perspective on the growth, status and prospect of sustainable finance was provided by the 2024 World Investment Report released by the UN Conference on Trade and Development (“UNCTAD”) which declared that while the sustainable finance market, as measured by the value of sustainable bonds and funds, increased by 20% to more than USD 7 trillion in 2023, there were signs of a slowdown as most of the increase was driven by cumulative issuance and rising valuations.[5]? The sustainable bond market showed only marginal growth—new issuances climbed 3% to USD 872 billion, bringing the outstanding value of the market to more than? USD 4 trillion (green bonds were the main driver of growth, while issuance in other segments, especially social bonds, fell).? The market value of the sustainable fund market increased 7% to USD 3 trillion; however, funds clearly were fending off strong headwinds as net inflows dropped from USD 161 billion in 2022 to USD 63 billion in 2023.[6]? According to the report, greenwashing was the most significant challenge to the sustainable fund market, a situation that required more attention to well-defined product standards, robust sustainability disclosures, external auditing and third-party ratings.? The report also noted that while most funds have adopted and published strategies to address climate change, only one in three have aggressively moved to reorient their portfolios by divesting from fossil fuels and reinvesting the proceeds in renewables.[7]
Consistent with its leadership in other areas of sustainability and corporate social responsibility, Europe continued to have the largest pool of sustainable investment assets globally as of 2022 and commentators have noted that sustainable investing has been broadly adopted in Europe and has reached the highest level of maturity compared to any other region.? The GSIA found that sustainable investing grew in Europe from USD 12 trillion in 2020 to USD 14 trillion in 2022 but that this growth failed to keep pace with broader market growth.? Specifically, the GSIA noted that the percentage of assets defined as sustainable in Europe has been declining, by around 5% each year, and speculated that this trend could be attributed to “increasing regulatory requirements regarding disclosures and a shift to a more risk averse reporting approach as part of an overall picture of increasing maturity of sustainable investing definitions and approaches as the industry develops”.[8]
The US trails slightly behind Europe.? The US SIF Foundation (“USSIF”) estimated that sustainable investment AUM held by institutional investors, money managers and community investment institutions in the US who use one or more strategies of ESG incorporation (and provide information on the specific ESG criteria incorporated in investment decision-making and portfolio construction) and/or file or co-file shareholder resolutions as publicly traded companies on ESG issues was USD 8.4 trillion in 2022, representing 12.6% of the USD 66.6 trillion in total US assets under professional management.[9]? To address concerns that investors were claiming to deploy ESG integration strategies but failing to provide adequate disclosure on specifics, USSIF modified its methodology for its 2022 report and excluded the AUM of investors who stated that they practice firmwide ESG integration but did not provide information on any specific ESG criteria they used.? Notably, this change, which was consistent with the regulatory initiatives discussed below to improve ESG-related disclosures and marketing practices, resulted in the sustainable investment AUM (USD 8.4 trillion) being much lower than the 2020 estimate of USD $17.1 trillion.??
The leading ESG criteria for US money managers in 2022 were climate change/carbon, military/weapons, tobacco, fossil fuel divestment, and anti-corruption; the leading ESG criteria for US institutional investors in 2022 were climate change/carbon, conflict risk (terrorist or repressive regimes), board issues (i.e., directors’ independence, diversity, pay and responsiveness to shareholders), sustainable natural resources/agriculture, and tobacco; and the leading ESG issues raised in shareholder proposals, based on the number of proposals filed with the US Securities and Exchange Commission (“SEC”) from 2020 through 2022, were ensuring fair workplace practices (i.e., ending de facto discrimination based on ethnicity and sex), disclosure and management of corporate political spending and lobbying, and climate change (i.e., assessment of climate risk and disclosure and efficacy of efforts to reduce greenhouse gas emissions).? While not yet among the leading categories mentioned above, both money managers and institutional investors in the US showed increased interest in social issues such as human rights, equal employment opportunity/diversity, and health and safety, likely a response to the challenges of the Covid-19 pandemic that had arisen during the period for which data was collected.[10]?
US financial institutions have lagged behind their counterparts in the EU and other parts of the world on sustainability issues; however, increasing awareness and concerns about sustainability, including among younger generations, have contributed to increasing levels of sustainable and responsible investing; an increased focus from the largest US banks and other financial institutions on sustainability risks, lending practices and related opportunities; development and evolution of sustainability risk frameworks by US insurance companies and related regulators; expanding adoption of federal and state policies around transition to low carbon energy; and financial innovation in many sectors alongside social innovation and cultural development.[11]? However, widening resistance to sustainable investment strategies in financial markets in the US, as well as to sustainability and disclosure requirements, has created a significant challenge for sustainable finance in the US.? For example, UNCTAD found that as of 2023 17 states had passed legislation prohibiting fund managers from considering ESG factors in their investment decisions or prohibiting states from contracting with asset managers that exclude certain industries, such as fossil fuels, from their portfolios.[12]
Data indicates that Asia is progressively catching up and that sustainable investing is gaining more traction in Asian countries outside of Japan, which was one of the earliest adopters of ESG-based investing.? The GSIA found that there continued to be strong growth in the Japanese market as of 2022, with sustainable investing assets increasing to USD 4.3 trillion from USD 2.9 trillion in 2020 and sustainable investing as a percentage of the Japanese market growing from 24% in 2020 to 34% in 2022.[13] ?GSIA data on the Australian and New Zealand market indicated growth in absolute dollars from USD 906 billion in 2020 to USD 1.22 trillion in 2022 and moderate growth in relative assets from 38% to 43%.[14]? The GSIA also reported that the scale of ESG investments in the mainland Chinese market has been growing rapidly and that as of September 2023 the market size for major types of responsible investments in China had reached approximately CNY 31.59 trillion (USD 4.35 trillion); however, the majority of this comprises green loans from commercial banks, with ESG investments from mutual funds constituting only a small portion.[15]? New policies and initiatives relating to ESG investing has also been introduced in Taiwan, South Korea, Hong Kong, ASEAN Member States and Malaysia.[16] ?
There were just 63 signatories to the Principles for Responsible Investing (“PRI”) at the time the PRI was launched in 2006; however, by the end of March 2023, the number of investor signatories had grown to 4,841 (a 10% increase over the prior year and a significant increase from 2,701 signatories in 2020).? As AUM calculations by the PRI are based primarily on reporting data, the most recent data available at the end of March 2023 was from 2021 and put the aggregate assets under management by all 3,826 PRI signatories (investors and service providers) at that time at USD 121.3 trillion.[17]? In October 2019 the International Monetary Fund reported that ESG funds accounted for around USD 850 billion in assets.? While early adoption of ESG factors among funds has been primarily on the equity side there have been indications that fixed income investors are becoming more comfortable with the concept as demonstrated by the growing rate of issuance of sustainability-linked bonds (“green bonds”).[18]?
At the same time, there has been a surge in regulatory focus on sustainable investment and developing approaches to integrating sustainable investment and sustainable finance instruments into the mainstream frameworks of governments, multinational enterprises and the global financial services industry.? Regulators around the globe, including in the EU and US, have increased their efforts to prevent misleading or deceptive fund names and require more detailed ESG disclosure by investment funds and advisors especially on issues such as climate change.? For example, in May 2018 the EC released its Sustainable Finance Package, a set of legislative proposals focusing on driving more capital towards sustainable investment projects and encouraging participants in the financial sector to change their operations to reduce environmental risks.? Key features of the package included adoption of an EU-wide classification system for sustainable investments and “environmentally sustainable economic activity”, requiring asset managers and institutional investors to demonstrate how their investments are aligned with ESG objectives and disclose how they comply with their duties and creation of a new category of benchmarks of standard indices and standardization of formatting for reporting of ESG disclosures.? In the US, the SEC moved to prevent misleading or deceptive fund names and require more detailed ESG disclosure by funds and advisors.? In Asia, stock exchanges in China and Hong Kong mandated disclosures of ESG matters by their listed companies and countries such as China and India began to require that asset managers must incorporate ESG methodologies, strategies and benchmarks into their investment decisions as opposed to the voluntary guidelines that have applied in the past.[19]
While progress on these initiatives has been slow and often contentious, the USSIF reported in 2022 that “trends researchers … [had begun] … to see multiple asset managers reporting a modest to steep decline in ESG AUM … [a sign that regulatory proposals] … are motivating asset managers to be more circumspect in what they consider to be assets that incorporate ESG criteria”.? Respondents to a survey used by USSIF to collect data for its report on sustainable investment in the US discussed above indicated that increased scrutiny by regulators would be a positive step toward the maturation of the sustainable investment industry and that “[a]sset levels will likely move lower to a truer base of real sustainable investing and managers will have to be clear about the underlying approaches they employ”.? Others predicted a smaller market “as firms realize that a rigorous, defensible ESG approach is quite challenging”; however, at the same time, there was a belief that features of ESG/sustainable focused products would become more mainstream and that a new wave of innovation could be expected from sustainable investors.? Another key to maturation of the industry, and reducing greenwashing, would be improvement of data and development and acceptance of consistent standards and methodology for measurement of impact.[20]?
This article is an excerpt from my recently updated chapter on Sustainable Finance . To learn even more, download my new book Sustainable Finance and Impact Investment: A Guide for Sustainable Entrepreneurs .
Notes
[3] 2022 Global Sustainable Investment Review: Executive Summary (Global Sustainable Investment Alliance, 2023) , 5 and 10-11.
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[4] Id. at 13-15.
[6] Id.? See also Investors pull cash from ESG funds as performance lags, Financial Times (June 5, 2024) (“Global investors are turning their backs on sustainability-focused stock funds, as poor performance, scandals and attacks from US Republicans hit enthusiasm for a much-hyped sector that has pulled in trillions of dollars of assets. Clients have withdrawn a net $40bn from environmental, social and governance (ESG) equity funds this year, according to research from Barclays, the first year that flows have trended negative.”).
[7] Id. at 11.
[9] 2022 Report on US Sustainable Investing Trends, Executive Summary (US SIF Foundation) , 1-2.? ESG incorporation strategies used by investors include ESG integration, positive/best-in-class screening, negative screening, impact investing, and sustainability-themed investing.
[13] 2022 Global Sustainable Investment Review: Executive Summary (Global Sustainable Investment Alliance, 2023) , 10 and 32-34.
[14] Id. at 10 and 29-31.
[15] Id. at 39.
[16] Id. at 40-41.?
[17] Annual Report 2023 (PRI) .
[19] Id.