2021: The year ESG grew up

5 Jan 2022 | In our first issue of 2022, we review a catalytic year for sustainable finance.

In 2020, sustainable investing reached fever pitch, for reasons both pure (the pandemic prompted reflections about ecological fragility and social interconnectivity) and pragmatic (ESG fund outperformance commanded a 20bps premium).

As per Newton’s Third Law, however, the backlash was acute in 2021.

The beginning of a new year is generally kind to ESG. January heralded the World Economic Forum at Davos and Larry Fink’s annual letter to corporate leaders, both of which hailed investors and businesses as commanders in the charge against climate change.

Come February, flow data arrived to fanfare. Morningstar christened 2020 a “year of broken records,” ushering in “a new era for sustainable investing,” in which 758 new sustainable funds entered the scene. OK, fine, 253 had been “rebranded or repurposed.” And sure, of those, 87% simply added words such as ‘sustainable’ or ‘ESG’ or ‘green’ or ‘climate’ without changing their holdings.

Whatever. March brought SFDR, which promised to make history of dishonest fund labels in Europe. But it wasn’t enough to suppress the kindling of 2021’s major ESG crisis—the discrepancy between methodology and marketing [read: greenwashing]—which garnered attention when ex-BlackRock sustainability head Tariq Fancy published his first critique of the industry (which we covered in ESG Clarity).

By April, attention turned to the US, where President Biden promised new emissions targets and the SEC took aim at ESG disclosures. As US-led enthusiasm for clean energy swelled, however, another problem brewed under the fund hood. iShares’s Global Clean Energy ETF, the poster child for the energy transition, started to buckle under the weight of its own success. Too much money, too few—and too small—stocks. (We wrote about that one in Environmental Finance.)

In May, the issue was taken up by the International Energy Agency, which honed in on the “looming mismatch” between renewable demands and mineral supply in a landmark report. It laid bare an uncomfortable truth about the energy transition: clean energy leans (heavily) on not-so-clean sources.

August was the industry tipping point. The IPCC sounded a “code red for humanity.” Fancy published a second (and third, and fourth) essay, in which he labelled ESG “a dangerous placebo that harms the public interest… like selling wheatgrass to a cancer patient.” Soon after, the SEC opened an investigation into DWS on the back of greenwashing allegations.

No wonder we touched nerves in September, with our flagship 2021 report that answered the question ‘do ESG funds have a significant positive real-world impact?’ with a resounding ‘no’.

COP26 in October reminded capital markets of the critical role they must play in the road to net zero. But it won’t be an easy one.

Carbon Action Tracker popped the promise of pledges with its November report, which revealed the world is careering towards a 2.4°C rise by 2100 if government policies are anything to go by. Sobering climate change news once again prompted the question: What’s a responsible investor to do? Work with or against the perpetrators?

By December, two inconvenient truths were self-evident. Bloomberg revealed to the wider world a reality that (somehow?) was known only to insiders: There’s a multi-billion-dollar chasm between what people think ESG achieves and what it actually achieves. And yet: Impact investments, constrained by scope in their current format, may not be able to plug the gap without a leap in sophistication. The energy crisis and its global ramifications forced home the idea that going green isn’t going to be easy, or fast, or cheap, or great for society, or, well, entirely green in the short term.

Neither fact undermines the case for sustainable investing, which is finally pushing past its idealistic adolescent phase: a healthy step for any maturing market. But they do introduce a much-needed dose of nuance, which will be key to any honest conversation about the opportunities and limitations facing responsible investors—not to mention a new generation of underserved, wised-up retail investors—in the decade ahead.

Turns out, the real world is complicated. Unlike financial metrics, it’s hard to wrap up extra-financial complexities into a single digestible rating or straightforward soundbite.

Sustainable finance is growing up. Two practical questions to ask in 2022: What will propel it to the next phase, and what comes after?