The politicization of environmental, social and governance (ESG) investing is pushing institutional investors, asset managers, and corporates away from publicly using the ESG label to identify their sustainability activities. Instead, they are switching to the use of the term “fundamental risk management” to refer to the same thing.
“ESG has become less about the label and more about fundamental risk management. Many of our clients and many of institutions in the market now want to have ESG or fundamental risk management, if you use the other term,” says Sebastian Schiele, head of Xtrackers mandates sales for EMEA and Asia-Pacific.
This trend has become evident in recent months, as more institutions and corporates who are publicly committed to integrate sustainability into their portfolios, find it increasingly challenging to talk about their sustainability initiatives and activities, in the face of political pressure from anti-ESG entities in certain markets, among other factors.
The trend is most evident among large, diversified asset managers who offer sustainability investing solutions in the form of building blocks, which include active strategies, passive strategies, and alternative strategies, in order to meet the requirements of their clients who focus on asset allocation to implement their respective portfolio strategies.
“I say publicly committed because in certain markets, it's now politically very difficult to talk about sustainability investing. If you take the US for instance, in one state you can get fined for taking ESG risks into account, while in another state you could be banned for not taking sustainability risks into account,” says Schiele.
“What we are seeing is that some of our clients now do not talk about ESG but about fundamental risk management, because they see that there are environmental risks in a portfolio, and if you build a strategy that is more resilient to climate change, you will deliver better risk-adjusted return for your end clients and your investors,” Schiele tells The Asset in an interview.
Evolution of ESG
But apart from the politicization of the ESG or sustainability label, a more important development is the fact that experts are now recognizing the “evolution” of ESG or sustainability investing into fundamental risk management.
An article published by the Enterprise Risk Management Academy (ERMA), a global learning centre for risk professionals, says: “ESG has now evolved into risk management. ESG was initially used to measure the environmental and social effect of a firm. However, it has since expanded to include the identification and management of climate-related, social-related, and governance-related risks that a company confronts.”
ERMA cites the World Economic Forum’s 2022 Global Risks Report and the Task Force on Climate-Related Financial Disclosures (TCFD) regulations to cite the connection between climate change and commercial risks.
As global attention swings to climate challenges, climate risk is increasingly seen as a commercial risk. It is now generally acknowledged that climate-related consequences on a corporation can be material and necessitate disclosure, largely as a result of the work of the TCFD, according to ERMA.
Meantime, governments are increasingly recognizing the connection between sustainability and risk management which is why sustainability-focused regulations, particularly rules that require increased transparency for risk management, are being introduced even in Asia.
“There is a big trend towards sustainability investing because obviously there are risks. But it's also predominantly because governments are committing themselves to net zero. Governments translate those commitments into regulation that will make regulation impact the companies, asset owners and asset managers. That's why we think that there's such a continued trend towards sustainability investing,” Schiele says.