Investing according to ESG criteria continues to polarize the financial community, especially in light of the Ukraine war. The controversy around ESG is likely to remain fierce in 2023, a five-point forecast by finews.asia reveals.

Last year was partly marked by major reservations about sustainable investing as asset management came under scrutiny, particularly with Russia's invasion of Ukraine in February 2022. The war pitted environmental, social, and governance criteria against each other, confronting companies, investors, and governments alike with several dilemmas in ESG investing.

Irreconcilable Adversaries

In Europe, governments reverted to using fossil fuels as they aimed to reduce their dependence on Russian gas. At the same time, weaponry was completely reassessed with the war. In light of energy security, military defense, and return on investment opportunities, investors began rethinking their positions.

Two opposing camps formed with activist investor groups on the one side, looking to push the concept of sustainable investment quickly and without compromise, while right-wing politicians in the US dismissed the ESG concept, saying it breached antitrust laws.

Although it is hard to predict which of the camps will prevail next year or how the debate will play out, we have drawn up some of the controversies sustainable investing is facing.

1. Poor Performance

By 2030, 25 of the largest European and US banks are expected to invest nearly 40 percent of total assets, or 15 percent of global GDP, in sustainable financial products. Irrespective of such vast sums, disappointments are inevitable, especially when it comes to returns.

According to critics, 2022 is a foreshadowing of things to come. ESG investments not only missed the rally in energy stocks but also suffered losses because they are overweight in technology stocks, which fell sharply in value. In addition, risk distribution in ESG portfolios is narrower than in traditional portfolios because the focus on ESG assets means that optimal diversification has to be sacrificed.

2. Lack of Standardization

Establishing a common framework for ESG disclosure remains a key challenge for 2023 and beyond. The EU's Sustainable Finance Disclosure Regulation (SFDR), used by the financial industry, is considered the most developed system, designed to increase transparency about how financial institutions integrate sustainability risks and opportunities into their investment decisions and recommendations. Because products outside the EU are assessed differently, a direct comparison across different financial centers is nearly impossible.

These difficulties are likely to worsen, as more countries push their taxonomies and classifications with different understandings of investor protection, specific requirements, and deadlines.

3. Confusing Downgrades

The European Union's Sustainable Finance Disclosure Regulation (SFDR), adopted in March 2021, requires asset managers to self-classify funds sold in the EU as Article 6, 8 («green») or 9 («dark green»), depending on their sustainability objectives. The new technical standards, effective from January 2023, require managers to disclose more information about their funds' ESG approach, sustainability risks, and impacts in pre-contractual documents and regular reports.

In advance of this enhanced disclosure rule, leading asset managers such as Amundi, Axa, and NN Investment Partners downgraded ESG funds with billions of dollars in client assets from the highest sustainability tier. Experts believe the downgrading of Article 9 products will continue until the EU Commission clarifies the definition of sustainable investment.

Critics say the many different interpretations of SFDR make it impossible to compare products in terms of their proportion of sustainable investments. Because there is no universal, objective, and strict regulatory framework for this type of investment, this is likely to become an ever greater drag.

4. Cynicism Around Greenwashing

German authorities conducted the first-ever greenwashing raid in May, searching the offices of Deutsche Bank subsidiary DWS to investigate greenwashing allegations. The move shook the industry, forcing it to come to terms with the practice being no longer classified as poor marketing, but a massive legal risk instead.

In 2023, regulators in other countries will likely crack down harder on greenwashing practices to restore lost trust and protect investors against misleading ESG claims. The European Securities and Markets Authority plans to introduce thresholds for the use of environmental, social, governance, and sustainability terms in product names.

In the face of rampant cynicism, a new practice called «greenhushing» has already made itself felt among climate champions. Many companies have now gone silent about their climate goals.

5. Anti-ESG Sentiment

Sustainable investing faces ever-stronger headwinds with accusations ranging from deception and ineffectiveness to secret agendas to impose «woke» values on capitalism and society. The politicization is particularly striking in the US, where Blackrock and its CEO Larry Fink served as easy targets for both sides of the political spectrum.

Florida and other Republican-led states have withdrawn funds with the accusation that the world's largest asset manager is pursuing goals other than returns.

Fink does not come out well in the two sides of a sometimes emotionally charged debate. Blackrock’s former chief investment officer for sustainable investing Tariq Fancy has called his former boss an «emperor without clothes» for avoiding taking a clear position in the ESG debate.

It is possible that anti-ESG sentiment could spread further with the Republicans taking control of the US lower house of Congress at the beginning of the year. A new bill to protect farmers from the SEC's upcoming climate disclosure rules is suspected to be under discussion.