As the COP28 meeting begins and the world looks to the financial sector to step up on the climate crisis, the global sustainable investment industry is finally coming to grips with allegations of greenwashing that have plagued it for years.
The Global Sustainable Investment Alliance (GSIA), the worldwide umbrella organization for green investing, has adopted a new, more rigorous definition of sustainable investing, drawing a clearer line between sustainable and conventional investment.
The new definition has some holes – it doesn’t deal with the controversial problem of sustainability-linked debt, for example. But with new data released on Wednesday, the industry’s leadership is refusing to count assets of fund companies and asset managers with fuzzy claims of environmental, social and governance (ESG) performance.
“It's effectively taking a different definition of what counts as sustainable than we have used in the past,” said GSIA chairman James Alexander in a media briefing. “You would expect that from an industry that's emerging that we don't use the same definitions that we used 10 years ago.”
The data was contained in the Global Sustainable Investment Review 2022, a report on global sustainable investment assets issued biennially since 2012. The last report in 2020, compiled under the looser definitions, estimated assets of the sustainable investment industry to be US$35.3 trillion. Under the new definitions in 2022, those assets are 14% lower at US$30.3 trillion.
There has been some growth in Europe and Japan, but this has been offset by lower numbers in Canada and especially the U.S., where the tighter definitions have been felt most.
“We want to address greenwashing and we're doing our part through this report,” said Alexander, who is also chief executive of the UK Sustainable Investment and Finance Association, one of the regional networks that make up the GSIA.
Maria Lettini, CEO of the U.S. Sustainable Investment Forum (U.S. SIF), said a tighter definition of ESG integration (incorporation of ESG analysis into the investment process) led to a big decline in reported sustainable investment assets in the U.S. between 2020 and 2022.
Unlike in previous years when industry researchers accepted ESG integration statements at face value, they have now excluded assets of companies claiming to “practise firm-wide ESG integration but didn't provide information on any specific ESG criteria,” she said.
The methodological change had a big impact on the estimate of U.S. sustainable investment assets, dropping from US$17 trillion in 2020 to US$8.4 trillion in 2022 (which was already reported last year). Canada also reported a slight decline from US$2.42 trillion to US$2.36 trillion.
“We wanted to make sure that they weren't just using the [sustainability] name straight out of the box and that didn't actually equate to the underlying theme or strategies,” said Lettini.
A problem for years
The issue of ESG integration has plagued the sustainable investment sector for years.
A 2015 report from the U.S. SIF found that eight of 16 large money managers claiming to integrate ESG into their investment practice failed to disclose specific ESG criteria being integrated or provided criteria only for certain asset classes such as property or fixed income.
This fall, the GSIA revised its definitions of sustainable investment strategies, including ESG integration. The new definition means ESG integration assets will only be counted if there is “ongoing consideration of ESG factors within an investment analysis and decision-making process.”
The change has dramatically altered the estimate of the share of the total investment market held by the worldwide sustainable investment industry from a whopping 38% in 2020 to 24% in 2022. The market share estimate in the U.S. went from 33% in 2020 to just 13% in 2022.
GSIA changed the definitions in collaboration with the Principles for Responsible Investment, with more than 5,000 signatory organizations managing more than US$120 trillion in assets, and the Chartered Financial Analyst (CFA) Institute, the global professional body for more than 190,000 investment managers and analysts.
ESG managers and funds mix and match strategies as they see fit. So in addition to ESG integration, strategies include screening (criteria determining whether an investment is permissible; I.e., tobacco or nuclear), thematic investing (investments in specified trends such as renewable energy), stewardship (the use of investor rights to influence corporate management on ESG issues, such as board diversity) and impact investing (investing with the intention to generate positive social or environmental impact alongside a financial return; I.e. community loan funds).
The definitions apply to general sustainable investment strategies and don’t drill down to address some problematic ESG investment products, such as sustainability-linked bonds (SLBs) and sustainability-linked loans (SLLs).
With sustainability-linked loans or bonds companies promise to pay financial penalties if they don’t meet predefined social and environmental performance targets. While linking corporate debt to sustainability targets can incentivize companies to make ESG improvements, a lack of standardized rules has opened the door to greenwashing, with some companies using the funds to continue business as usual with little ESG impact.
Alexander said the definitions of sustainable investment likely will change over time, which means there could be further tightening.
“I am very confident with the data that's in this report and with the numbers that it presents, but I'm not going to say that, in future versions of this report, we won't see different methodologies, and that's as it should be.”
Lettini said she believes public policy will be a strong driver for the sector in the U.S. This includes new rules regarding ESG fund names by the Securities and Exchange Commission, new California rules imposing corporate greenhouse gas emission disclosure requirements and investment incentives for sectors such as renewable energy under the federal Inflation Reduction Act.
While it appears the estimated size of the sustainable investment industry in the U.S. has shrunk by more than half in the last two years, the reality is that it never was the size claimed by USSIF and GSIA. The industry relied on incorrect assumptions that ESG claims equaled ESG action, an error that has now been addressed.
“We are ensuring that the methodology behind sustainable investment assets has increased rigour,” said Lettini. “That has translated into a number that I think we can feel much more comfortable standing behind.”
Eugene Ellmen is a former executive director of the Canadian Social Investment Organization (now Responsible Investment Association). He writes on sustainable business and finance.
