2020 has been a record year for inflows into ESG funds. Demand for ESG investments has shown no sign of abating. According to Bloomberg, inflows into ESG-ETF's have surged this month, taking the amount received in 2020 to over USD 50 billion, more than double that of last year.
Joe Biden's election win is a massive boost for ESG globally
With Joe Biden as the President elect of the United States, the global ESG environment will see a massive boost - inflating further demand for ESG funds - and complement the strong enabling environment for ESG that the European Union has been building on. Biden plans to re-join the Paris Climate Agreement, which President Trump exited. He wants to make electricity production carbon-free by 2035 and have the US move to net zero carbon emissions by 2050. His strong commitment to climate change and ESG is borne out by the fact that he has created a special position - at the cabinet level - to advise his administration on ESG and climate change, by appointing John Kerry, former secretary of state as special presidential envoy of climate change. John Kerry will sit on the National Security Council (NSC). This is for the first time ever that the NSC will include an official dedicated to climate change, unequivocally endorsing the Biden administration’s commitment to addressing climate change as an urgent national security issue.
Stakeholders should prepare for rapid change on ESG regulation, in Europe and the US
The pace at which ESG inflows are accelerating has led to a demand for standardized data on the definition of ESG, regulatory oversight on ESG funds and full transparency on what they are investing in. While international efforts around ESG issues have produced various recommendations and guidance, they have been in the form of soft law, which is non-binding. With President Trump's disbelief in climate change, the United States used to stand out as a materially relevant financial center which neither attempted any regulatory scrutiny on ESG nor encouraged ESG investments in pension funds. As a result of the strong demand for ESG funds, asset management firms have been incorporating ESG considerations into their investment decisions. However, these trends have been occurring without much public policy or regulatory support.
Stakeholders should now be prepared for a rapid change in regulation, definition, and transparency of ESG, as mandatory legal obligations come into force. These requirements mean that firms will have to build consideration of ESG issues into their investment and advisory processes, and provide investors with consistent and reliable disclosures of ESG issues in their products and services.
The Biden Administration led Securities and Exchange Commission (SEC), will likely look for expanded ESG disclosure requirements by companies, making these mandatory. The focus on ESG data will also lead to greater enforcement risks as the SEC and other regulators increase scrutiny of ESG disclosures and their accuracy.
ESG disclosure standards are already in place in the EU, which the European Commission has sought to develop further in recent years. As part of its Action Plan for Sustainable Finance, the EU has passed an ESG related Disclosure Regulation and the European Parliament has adopted the text of a Taxonomy Regulation, both of which are designed to form central pillars of the new sustainability framework. The "Taxonomy Regulation" is set to establish an EU-wide taxonomy on environmental sustainability, and will, in theory, give both corporates and financial institutions a common language to identify which activities and financial instruments may be considered environmentally sustainable. Pursuant to the Taxonomy Regulation, firms will need to apply "technical screening criteria" (i.e., performance thresholds) to assess whether specific activities undertaken by investee companies contribute to climate change adaptation or to an increase in climate resilience.
These moves will push the regulatory environment to become more favourable toward sustainable investing, and the mandatory disclosure of climate and other material social and environmental risks will also help investors.
It will not be long before India, too, follows in the footsteps of Europe and US on ESG disclosures
With the increasing launch of ESG funds in India, it is a matter of time before SEBI - in line with its peers in US and Europe - comes up with its own standardization of norms and disclosures of what constitutes ESG. India, on account of both, its vast and unique geography and its high density of population, faces very high climate change related vulnerability. It will be imperative that climate material issues - chiefly carbon and urgent decarbonization initiatives - receive the attention of regulators, while drafting regulation for ESG disclaimer in India.
Authored by: Abhay Laijawala, MD and Fund Manager, Avendus Capital Public Markets Alternate Strategies LLP
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