For now, the giants of ESG are becoming this year’s laggards. The world’s biggest ESG exchange-traded fund — BlackRock Inc.’s $20.9 billion iShares ESG Aware MSCI USA (ticker ESGU) — has lost almost a quarter of its value this year. The ETF, which holds shares of Meta, Exxon Mobil Corp. and Chevron Corp., performed even worse than the MSCI World Index amid a global selloff.
Perhaps ironically, the BlackRock ESG ETF’s exposure to the kind of big tech stocks that Baker was trying to avoid is why it’s done so badly this year. In fact, ESG’s early flirt with tech — due to its perceived low carbon footprint — has been the undoing of many an ESG fund manager in 2022.
ESG’s recent performance dip has coincided with a rise in notoriety. Mike Pence has called it a “left-wing” conspiracy that Republicans must “rein in.” Elon Musk has dubbed it “the Devil Incarnate,” while Republican donor and hedge fund boss Peter Thiel has described it as a “hate factory.” Meanwhile, researchers at the European Central Bank have said it remains “unclear” whether the ESG investment industry is actually helping the fight against climate change.
Against that backdrop of confusion, disillusionment and outright anger, regulators are sharpening their teeth. In Germany, the authorities stunned the ESG asset management world on May 31 by launching a raid on the headquarters of Deutsche Bank and its fund unit, DWS Group, amid allegations of greenwashing. Over the weekend, it emerged that the US Securities and Exchange Commission is investigating potentially dubious ESG claims at the investment management unit of Goldman Sachs Group Inc.
As normal people wonder whether ESG is worth it, a new regulatory framework is about to make their opinions a lot more important to the fund management industry.
In Europe, whose ESG rules are fast becoming a global benchmark, asset managers are desperately trying to prepare for a looming deadline that will force them to care a lot more about retail client perceptions. Starting in August, the European Union will require financial advisers to make sure individual investors get exactly what they want out of their ESG holdings, even if that means sending them to a competitor. The change applies to all fund managers targeting European investors — whether they’re in the US or Asia — and is likely to influence regulatory frameworks across other jurisdictions, if history is any guide.
In practice, that means that if a client thinks it would be weird to include Meta in an ESG fund, an investment adviser needs to make sure they know that. Lawyers advising the fund industry are trying to prepare their clients for the risks ahead.
“There’s a real concern that retail investors don’t understand the different faces of sustainability,” said Lucian Firth, a partner at law firm Simmons & Simmons in London who advises ESG fund managers. “What is sustainability? It means lots of different things to different people. Does the retail investor know? They might have in their mind that this stuff should do good and you see these adverts that my money can do good and make me returns, but what do they actually mean?”
The upshot is “there will be more litigation risk,” he said.
Europe’s main banking association, EBF, has already warned of the “great legal uncertainty” the new regulatory framework represents for the finance industry, as well as the “huge confusion” for clients. It’s lobbying to have the new rules, which fall under Europe’s revised Markets in Financial Instruments Directive, delayed by almost a year.
European authorities have so far shown no inclination to grant the requested delay. And consumer protection groups are warning that any hold-up would be bad for retail investors.