The Puzzle of Navigating ESG Challenges Amid Shifting Political Landscapes

For asset managers seeking to access global capital, an inevitable challenge now faced is balancing the expectations of investors who have increasingly strong yet diverging views on sustainable investment practices. Previously, this task was more manageable, with anti-ESG sentiment largely confined to a small but vocal group of US-based politicians impacting public asset owners. However, with the Trump administration now taking shape, anti-ESG rhetoric will become policy, and although not all US based investors will have such explicit stances, the US investment regulatory landscape will actively not consider ESG factors in contrast to the direction being taken by investors and regulators around the world.

In this diverging environment, managing clients across the globe can feel impossible-while getting it wrong risks losing investor confidence and access to capital.

The US: The New Epicentre of the ESG Boycott

As discussed in our recent piece “ESG Under a Trump Administration”, it is almost certain that the US will take swift action to limit the scope and prevalence of “ESG-related activities, which often promote unpopular, progressive policy objectives”, in the view of the House Committee on Financial Services. Through a combination of federal and state-level legislation, combined with litigation and public advocacy campaigns from anti-ESG bodies, any corporate or asset manager that has made public statements about their ESG processes will find themselves under unprecedented levels of scrutiny. For example, ERISA plan rules may be tightened to now explicitly prohibit the integration of ESG factors in the investment process, as they will be deemed to be “non-pecuniary”. A rule that the Department of Labor has changed on multiple occasions under recent administrations. Recently, the Employee Benefits Committee of American Airlines was sued for breaches of fiduciary duties of loyalty and prudence due to their investment in Blackrock, who allegedly pursuing “non-financial and non-pecuniary ESG policy goals through proxy voting and shareholder activism” despite the American Airlines plan not being invested in any “ESG” funds.

Although NorthPeak believes that the actions outlined above are predicated on a fundamental misinterpretation of the term ESG and its objectives, something we have also extensively written about, the reality is that this ship has already sailed.

How are Asset Managers Responding?

In response, asset managers may consider the best solution is strategic silence or to even renege on commitments made towards anything ESG, sustainability, and responsible investment related. Indeed, we have seen asset managers move to scrub such ESG-related terminology from their public-facing material, such as website, policies and reporting. This approach could be considered sensible, especially in the context of other regulation, such as ESMA’s Guidelines on Fund Names and the UK Sustainability Disclosure Rules, all of which are designed to prevent greenwashing within the investment industry. However, we strongly advise against making drastic changes to underlying investment practices, such as ceasing to consider ESG factors in decision-making or halting the collection of ESG-related information from portfolio companies.

Even if the US takes a divergent path on sustainable investment, global investors and regulators are continuing to demand the integration and reporting of ESG factors. SFDR will continue being critical for any asset manager looking to access European capital, and there remains an expectation amongst European investors that any fundamental strategy should meet Article 8 disclosure requirements (i.e., promoting environmental and/or social characteristics). UK asset owners, with AUM above £1 billion, will still be required to provide annual TCFD-aligned reporting, and EU asset owners, with 500+ employees, will need to complete annual Principle Adverse Impact reporting, both of which necessitate you providing data on your investment portfolios.

Beyond these regulatory imperatives, asset owners will have their own sustainability agendas that they will continue implementing, regardless of the political environment in the US. For example, according to Morningstar’s Voice of the Asset Owner Survey 2024, which surveyed 500 asset owners, representing $18 trillion in AUM, 67% believed that ESG had become more material over the past five years, whilst only 13% said it has become less material. $9.5 trillion of AUM, across 88 asset owners is still part of the Net-Zero Asset Owner Alliance, all of whom have committed to ensuring their investment portfolios are carbon neutral by 2050. In fact, the political environment around net-zero may mean that asset owners take an even more proactive approach for ensuring they are on track to meet their net-zero goals, resulting in further scrutiny for underlying asset managers.

We even recently spoke to a global investment consultant, who categorically stated they would not engage with any asset manager unless they could provide the following information on an annual basis:

• TCFD and GHG Emissions Reporting
• Engagement Reporting
• Exclusions Reporting
• Human Rights & Modern Slavery Reporting

What’s clear is that no amount of political change in the US is going to fully insulate asset managers from increasing global responsible investment demands.

Our Recommendations for Asset Managers

The challenges you will face over the next four years simply can’t be solved by changing a few fund names and a quick update to your website. The reality is that you will still need to substantially engage with responsible investment in one form or another, and a short term, reactionary approach means that sooner or later you will find yourself caught out. In our previous piece, we recommended that asset managers, go back to basics, and revisit whether their ESG and responsible investment approach is sufficiently grounded in financial materiality. This is something we stand by and strongly believe that successfully navigating this new environment requires you to have a responsible investment approach that directly contributes to long-term value creation, risk mitigation, is being sufficiently documented and accurately communicated to relevant stakeholders.

How Can NorthPeak Support You?

Developing a resilient responsible investment approach that resonates across the investor spectrum takes time and can strain internal resources. As a full-service advisor, NorthPeak Advisory specialises in tailored advisory and support packages, aligning with your investor base, regulatory demands, and reporting needs.

Our support package for asset managers includes the following services:

1. Mock Responsible Investment Examination

Our mock examination delivers a thorough evaluation of your responsible investment policies, practices, and procedures. This audit-driven review highlights areas of potential misalignment or vulnerability, aiming to:

• Pinpoint gaps and risks that may draw regulatory or investor scrutiny.
• Strengthen your investment process and align with regulations and investor expectations.
• Enhance how you present your responsible investment and ESG efforts to build trust and credibility.

2. Pre-Investment ESG Due Diligence

Our ESG due diligence offers a comprehensive approach to uncovering and realising additional financial value, which is often overlooked or not effectively priced in with traditional financial due diligence. By clearly demonstrating the financial materiality of sustainability factors, we ensure explicit alignment with your fiduciary responsibilities. Our pre-investment ESG due diligence includes:

• Leveraging our proprietary materiality assessment process to understand exposure to material sustainability factors, enhanced by sector-specific expertise for a refined analysis.
• Identifying how ESG factors influence key risk and value drivers, such as customer base, revenue streams, workforce dynamics, and industry trends.
• Providing actionable recommendations for addressing identified issues and highlight areas requiring immediate attention or further investigation.

3. Sustainability Reporting

Simplify your sustainability reporting process with our expert support, designed to ensure regulatory alignment and effective communication to meet investor expectations:

• Meet the requirements of global standards like SFDR, TCFD, TNFD, and PRI.
• Confidently respond to bespoke investor DDQs with precise and tailored communication.
• Deliver transparent and timely disclosures that resonate with investors, consultants, and regulators alike.

If you are an asset manager potentially caught in the diverging ESG landscape, feel free to reach out to NorthPeak’s expert responsible investment consultancy team at info@northpeakadvisory.com with any queries or concerns you may have.