There is no question that ESG is in the ascendancy. “As early as a few years ago, LPs demanded little other than an ESG ethos,” says Paul Buckley, founder and managing partner of FIRSTavenue. “Today, they need to see a structured approach with dedicated expert ESG staff and clear and measurable ESG targets. In the future, they are likely to demand that ESG is embedded into all aspects of the investment process.”

But there are some signs of dissent. When he resigned this summer, HSBC Global Asset Management’s head of responsible investments, Stuart Kirk, spoke of “the nonsense, hypocrisy, sloppy logic and groupthink inside the mainstream bubble of sustainable finance”.

“More important than the precise wording – ESG, sustainability, impact – is the sea change they represent”

Yves-Maurice Radwan
Commerz Real

In the US, two Republican-led states have actually introduced anti-ESG regulations. In August, Florida governor Ron DeSantis and the State Board of Administration adopted a resolution prohibiting state fund managers from considering ESG factors when making investment decisions, and updated their fiduciary duties, restricting them to consideration of “pecuniary factors”.

Florida’s move follows a similar initiative from Texas’s state comptroller Glenn Hegar. Hegar published a blacklist of financial firms (including BlackRock, UBS and Schroders) which he asserted are boycotting oil and gas companies. He also ordered state retirement and school funds to divest holdings in those firms and their investment vehicles.

Hegar was clear in his motivation: “The environmental, social and corporate governance movement has produced an opaque and perverse system in which some financial companies no longer make decisions in the best interest of their shareholders or their clients, but instead use their financial clout to push a social and political agenda shrouded in secrecy.”

‘An umbrella term’

Arguably, the root of this trend was the Trump administration’s Department of Labor directive from 2020: “The use of terms such as ESG, impact investing, sustainability and non-financial performance metrics, among others, encompass a wide variety of considerations without a common nexus and can take on different meanings to different people. In part, the confusion stems from the fact that, from its beginning, the ESG investing movement has had multiple goals, both pecuniary and non-pecuniary.”

Christian Schütz, director, ESG at Golding Capital, welcomes “a healthy debate” but admits there is “quite some confusion about the topic of ESG. It has become an umbrella term for a variety of aspects, convictions and not least regulation”.

Stan Miranda, founder of Partners Capital, agrees. He notes that the moves by Texas and Florida reflect that “ESG is too many things wrapped up in just one package”. This is “putting a spotlight on what ESG is actually about. What does it really mean? At the moment, ESG is just too disparate and all-encompassing”.

“The pace of this monumental change over the past few years has been daunting to many stakeholders,” admits Yves-Maurice Radwan, head of Green Deal Infrastructure at Commerz Real. They were already “faced with numerous other challenges, from changes in monetary policy to geopolitics. The topic of ESG has at times seemed omnipresent and lacking technical details in how to implement it”.

This could be a good time for GPs and LPs to assess what each means by ‘ESG’. A few developments now conspire to rebalance ESG considerations. Buckley notes “the rise of energy prices is inordinately benefitting LPs who derive capital from fossil fuel production. Middle Eastern LPs are set to become a more important source of capital”.

He also feels that “LPs have developed a strong appetite for ESG-friendly strategies over recent years with clear focus on greenhouse gas emissions reduction. There has been less focus on the ‘S’ in ESG”. The cost-of-living crisis means “LPs – particularly those with employee stakeholders − will likely soon care as much about livelihoods creation as GHG emissions reduction”.

Will the pushback spread?

Buckley notes that 19 other US states are signatories to anti-ESG conventions. And Jose María Ortiz, who advises infrastructure investors on nature-based solutions at Palladium, is worried. “What’s happening in the States is of direct concern to me. There are many nature-based solutions that are being undertaken by state governments in the US such as California. My concern is that the activities of Texas and Florida could spill over into a broader political backlash against fighting climate change.”

But other factors will limit the scope of a backlash. “We are definitely seeing a pushback on ESG matters in certain areas as political partisanship has focused on ESG,” says Michael Kirwan, who advises clients on ESG matters at international law firm Foley & Lardner. But “while political discourse can make a word or phrase unacceptable, it is unlikely that the tenets of ESG are going to go away. ESG is fundamentally a risk management concept”.

“My concern is that the activities of Texas and Florida could spill over into a broader political backlash against fighting climate change”

Jose María Ortiz

This is particularly true in Europe. “More important than the precise wording – ESG, sustainability, impact – is the sea change they represent,” says Commerz Real’s Radwan. “Most regulators, institutional investors and asset managers have made a profound commitment. This willingness and aspiration to consider, quantify and optimise sustainability aspects in investments is here to stay. This tide is too big to turn back.”

Schütz agrees: “Constantly rethinking what ESG means, how it’s applied and what its limitations are is of course part of any concept including ESG.” But “no investor or lawmaker will turn back the clock on this”.

Having said that, “the most important issue for GPs to navigate is the minefield of evolving regulation”, says Buckley. “The EU and UK have employed ‘the carrot’ in the form of clear but evolving fund classification standards. Meanwhile, the SEC has employed ‘the stick’ to set highly public examples of prominent fiduciaries failing to achieve the right regulatory standards.”

Overall, he says infrastructure investors have learned the following: “The generational switch from traditional to ESG-based investing needs to be carefully managed.”