By now, everyone has heard and read about ESG backlash, and while primarily in the United States, the implications are far-reaching. With the investment industry’s continued growth, now is a good time to reflect on what the politicization of the industry means for the long term. Does it represent the complete death of ESG, as some suggest, or will it experience a natural evolution as the industry matures?

Given the size of the U.S. investment industry – which according to WTW (formerly Willis Towers Watson global risk advisory) boasts 15 of the 20 largest firms globally – we are particularly sensitive to what happens across the border and this trend we’re seeing can offer insights into what may lie ahead for Canadian companies and investor relations professionals.

ESG as a Political Tool   

In my view, ESG is being used as a political tool. Pension funds, via state legislation, are being banned from doing business with certain firms regardless of financial performance or cost to the beneficiaries and this is not good for anyone. It has been reported that 165 pieces of ‘anti-ESG’ legislation in 37 states were introduced in 2023 alone and while the vast majority have failed to progress, the chilling effect is clear. These types of efforts ignore what mainstream investors have come to accept – that environmental, social and governance issues can be material.

Republican efforts to restrict ESG being applied in asset management have unfairly characterized ESG as solely furthering environmental and social goals, largely focusing on climate change. While there are products and funds designed to limit exposure to certain industries like tobacco or fossil fuels, most investors are not applying ESG in this way. They are assessing: how companies are exposed to physical climate risk; how companies are managing human capital to reduce turnover costs and maintain high engagement among staff; and how effective companies are in maintaining a social license to operate. It is hard to see how these are not material issues that should be and are being considered by investors.

Disclosure and Accountability Goes Both Ways

Just as investors have been asking a lot of portfolio companies in terms of ESG disclosure, regulation on investors themselves is growing. In the U.S. and Canada, regulators are clamping down on greenwashing in an industry where some have exaggerated their ESG credentials. For example, the U.S. Securities and Exchange Commission has altered its ‘Name Rule’ to require 80% of a fund to match the advertised name. While broader than just ESG funds, this change is significant and takes aim at funds that are marketed as sustainable or green.

Across the pond, investors are facing even more widespread scrutiny under the Sustainable Finance Disclosures Regulation (SFDR). According to this European rule, investors must: describe how they are aligned with the European Union taxonomy environmental objectives; classify funds according to how sustainable they are (Article 6, 8 or 9); and disclose Principle Adverse Impacts (PAI) at the entity level of their portfolios.

I raise this trend for two reasons. One is for companies to know they are not alone in a world of increasing reporting burden but also to be aware of the increasing pressures on investors to justify some of their actions.

The Future of ESG

As much as I dislike ESG being used in the culture wars of the U.S., I am sympathetic to the idea that it was time for the industry to evolve and mature. Investors need to be able to make informed choices, especially at the retail level, with access to comparable data and product descriptions. In short, ESG broadly speaking needed to grow up and some industry guardrails were required.

However, any claims that ESG is dead or was just a fad are grossly exaggerated in my opinion. Companies should not simply abandon their ESG strategies and let related reporting fall to the wayside. The investors that I know have not changed their processes or practices. There may be changes to the way they communicate what they do, but how they incorporate ESG into investment decision-making remains stable.

Based on this view, companies need to remain true to their ESG strategy and be diligent in understanding how ESG issues relate to and interact with this strategy. This is even more important now that the International Sustainability Standards Board (ISSB) has finalized its standards on climate and broader sustainability. ISSB has truly become a global baseline for reporting and companies need to prepare. If you are not convinced, take a look at the list of investors that make up the International Investor Advisory Board for the ISSB. The next step in this process is for jurisdictions to formally adopt the ISSB, as encouraged by the endorsement of the International Organization of Securities Commissions in July of this year.

Within this context, the narrative in the U.S. simply becomes noise, as the majority of investors have acknowledged and understand how ESG matters are material. For investor relations professionals, your job will become more complex as these issues begin to mesh with the financial statements. The line between ESG and everything else will become blurry as it will just be central to – and embedded in – the business.

There will be more scrutiny on ESG data, which also means the inclusion of finance and auditors. ISSB is silent about assurance for ESG reporting, leaving it to the individual jurisdictions to work out, but it is inevitable. That won’t happen tomorrow or the next day, but companies should start preparing and engaging with auditors for this eventual reality.

In a world where social inequality, labour strife, wildfires, floods, geopolitical risk and inflation dominate the headlines, how does a business strategy not include ESG? This is true whether you are a utility company facing new regulatory proposals on decarbonization, a consumer goods business trying to understand spending patterns, or a mining company on the hunt for the essential minerals to meet projected electric vehicle demand. In any of these scenarios, ESG cannot be ignored in strategic business conversations, regardless of political noise. Investors will continue to demand the disclosure they need, and investor relations professionals will continue to be central to meeting that demand.

Jennifer Coulson is Vice President, ESG, Public Markets, at BCI.