Why big investors aren’t giving up on ESG

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Canada’s institutional investors aren’t giving up on weighing environmental, social and governance factors when deciding what to include in their portfolios, even in the face of economic and geopolitical crises. If anything, they’re doubling down.

Russia’s invasion of Ukraine, energy-supply shortages and inflation top the list of issues that have investors on edge this year. Along with all that comes the need to identify safe havens for money in a volatile market. No surprises there.

One might think this list of worries would crowd out ESG, but the opposite has happened. With increased regulatory scrutiny of ESG claims, and a recent series of hefty fines meted out for greenwashing – when sustainability claims turn out to be mere marketing fluff – investors are demanding more and better environmental and social data from companies.

Fears of serious financial penalties have also prompted investors to shore up their own programs, according to a survey of 37 big-name Canadian investment firms by the Montreal-based ESG consultancy Millani. The respondents included a mix of generalist and ESG-specialist asset managers, who offered some fascinating responses to big questions about sustainability and investing.

Harsh and speedy enforcement in Europe and the United States has taken investors aback, and action by regulators has become a big risk factor. But the industry largely views it as positive, because it could bolster compliance and breed more credibility for ESG in a tough environment, according to Milla Craig, Millani’s founder and chief executive.

Ms. Craig said wider enforcement will push companies whose ESG documentation has largely been a marketing exercise to improve their practices.

“From a business standpoint, we’ve been seeing an increase in demand around this, but it became clear as we did this report that the investment community is taking this very seriously,” she said.

ESG is facing a political and market backlash. Will it survive?

Financial policing resulting in real consequences is one of several crosswinds that have battered the ESG world in 2022, following a massive flood of capital into investments promising righteousness with returns. Among other issues, sustainable investing is receiving pushback from some corporate leaders, including Tesla’s Elon Musk.

The idea of investing through a lens of environmental sustainability has also been under pressure from politicians in Texas and other Republican-dominated U.S. states, who portray it as an affront to their fossil-fuel industries. In addition, the flow of money into sustainable funds has slowed recently, after setting records earlier in the pandemic.

With regulatory standards tightening, the U.S. Securities and Exchange Commission fined BNY Mellon US$1.5-million in May for misstatements and omissions about ESG factors that went into investment decisions for some of its mutual funds. The SEC said BNY Mellon implied the funds had been subjected to ESG quality reviews from 2018 to 2021, when that was not always the case.

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. The unit has been the subject of investigations in Germany and the United States. DWS’s former chief sustainability officer alleged hundreds of billions of dollars of assets under management that were “ESG-integrated” were misleadingly represented to investors. The CEO of DWS subsequently resigned.

This type of enforcement action has yet to happen in Canada. But the fact that it’s happening elsewhere highlights the need for companies and their investors to build up in-house technical expertise on non-financial risks, such as those related to companies’ environmental initiatives or work-force diversity. They must also stay up to speed on fast-developing domestic and global procedures for disclosure, Ms. Craig said.

This is not just playing out in public markets. As those markets remain volatile, increasing interest in private equity and real estate is fuelling demand for better disclosure there, too.

“The desire’s there – or the fear, perhaps – but it is happening,” Ms. Craig said.

The Millani survey, which gauged the sentiments of portfolio managers from such firms as Desjardins Global Asset Management, RBC Global Asset Management, CIBC Asset Management and AGF Management Ltd., found that a movement toward “transition investments” – investments in emitters that have made detailed decarbonization plans – was picking up steam.

Macroeconomic factors and an overall improvement in conventional energy shares after a years-long losing streak are partly behind this, as well as an acknowledgment of the importance of resource industries to the Canadian economy.

But when it comes to writing cheques, institutional investors expect companies to have strong ESG programs in place, solid disclosure of emissions and reduction plans, as well as strategies to get to net-zero emissions. Consistently, respondents said they wanted climate-related targets to be a factor in executive compensation.

There is no better example of this type of investor attitude than the recent formation of Climate Engagement Canada, a coalition of Canadian investor groups that has targeted 40 high-emitting companies. The group says it aims to push those companies to set tougher emissions-reduction targets and advance the transition to a low-carbon economy.

“It’s isn’t just, ‘I’m in because it’s hot and exciting. There are expectations. In order to get our capital, you need to demonstrate what the plan is, and you need to execute on that plan – the same way you would on your financials,’” Ms. Craig said.

Jeffrey Jones writes about sustainable finance and the ESG sector for The Globe and Mail. E-mail him at jeffjones@globeandmail.com.

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