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A fishing boat passes the West Pubnico Point Wind Farm in Lower West Pubnico, N.S., on Aug. 9, 2021.Andrew Vaughan/The Canadian Press

Climate change is the top global problem and biggest source of opportunity for Canada’s $3-trillion responsible investing sector, while worries about greenwashing and increasing regulatory scrutiny are tempering the sector’s growth.

Investing through an environmental, social and governance (ESG) lens is getting more sophisticated, as asset managers deploy several different strategies to deal with risk, from integrating baskets of metrics into buy and sell decisions, to concentrating on specific themes, such as climate, workplace inclusion and water conservation, according to a state-of-the-industry report from Canada’s Responsible Investment Association (RIA).

All of this comes amid increasing controversy following high-profile investigations and fines for false and misleading environmental claims, as well as a backlash against ESG efforts, especially in the United States. The resulting chill is seen as a limiting factor in the sector, the report found.

Environics Research conducted the survey on behalf of the RIA. It found that, over the past two years, assets under management specific to the responsible investing realm have fallen to $3-trillion from $3.2-trillion, a figure RIA officials see as a floor for its members. The RIA comprises asset managers, asset owners, pension funds, service providers and others that collectively oversee $42-trillion in assets.

The decline is due to a few factors, including a change in reporting methods as the RIA employed a new firm to collect and assess the data. In addition, major asset management firms have become more cautious in how they define responsible investing (RI) and ESG assets, said Patricia Fletcher, chief executive officer of the RIA.

Asset managers are also employing responsible investing teams with more experience and knowledge than in the past, and they are much more critical of how the assets are defined, Ms. Fletcher said in an interview.

“What’s becoming more and more clear is the definitions of RI are in flux. There are a lot of global initiatives related to ESG and RI disclosure in effect and emerging, and there’s a really conservative tone being taken,” she said.

The report shows ESG integration – in which investors employ a broad set of ESG metrics to manage risk – is the most-used strategy, at 94 per cent of RIA members, up from 89 per cent two years ago. That is followed by negative screening, or excluding companies or industries based on their products or business practices, at 91 per cent, up from 72 per cent. The top industries targeted by exclusion policies are weapons and military hardware, tobacco, fossil fuels and gambling.

Other main strategies include corporate engagement, or using shareholder clout to push green and social proposals, as well as positive screening and thematic investments – building portfolios that pursue well-defined sustainability solutions.

Forty-six per cent of respondents run impact funds, which are structured to generate measurable environmental and social outcomes alongside financial returns.

On corporate engagement, the RIA was a force in this year’s launch of Climate Engagement Canada, a coalition of institutions pushing 40 companies in industries such as energy, utilities, mining, transportation and consumer goods to improve climate-related disclosure and align their advocacy with the goals of the Paris Agreement.

Meanwhile, increased regulatory and public scrutiny of ESG investing is tempering excitement after years of growth, the survey found. Apart from greenwashing concerns, the industry is waiting for clarity on disclosure and reporting standards, as well as definitions of what constitutes green technology, from a number of institutions. These include securities regulators and the new International Sustainability Standards Board, Ms. Fletcher said.

Over the past year, ESG has also become the target of a political backlash, especially in the U.S., where some politicians in Republican-controlled states have sought to prevent institutions from using sustainability measures in investment decisions, in the lawmakers’ efforts to protect the fossil fuel industry.

At the same time, credibility been called into question globally. Last spring, the U.S. Securities and Exchange Commission fined BNY Mellon US$1.5-million for misstatements and omissions about ESG factors that went into investment decisions for some of its mutual funds. That same month, police raided the Frankfurt offices of Deutsche Bank AG’s asset-management division, DWS, in connection with accusations of investment fraud related to greenwashing.

“I think there’s a wait-and-see mode of what’s going to happen in the coming months, and an active desire for clarity and certainty to help shape where the industry goes from here,” Ms. Fletcher said.

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