ESG Backlash in the U.S. and Europe: Shifting Sentiments and Regulations

Earlier this month, several leading U.S. financial institutions withdrew from Climate Action 100+, an international coalition of money managers committed to pushing large companies to address climate issues. Their withdrawal is the most recent episode in a growing trend of Wall Street retreating from earlier environmental commitments amid rising political divisions and financial pressures. This trend is mirrored in Europe, where a green backlash is also emerging. Nonetheless, the EU is forging ahead with climate disclosure rules, and sustainability – if not environmental, social and governance (ESG) by name – remains a top value for consumers and an agenda item for the Biden administration. Corporate leaders will be walking a thin line to balance the conflicting demands of different audiences, as well as complying with both U.S. and EU sustainability reporting requirements.

Backlash in the U.S. and EU

Following a late 2010s and early 2020s investing furor over ESG investing, recent years have brought with them rising backlash to climate-focused investing as political division in the U.S. has grown. Several Republican-governed states blacklisted money managers with public sustainability commitments and introduced legislation aimed at limiting the ability of financial institutions to include ESG considerations in investment strategies. Wary of political contention, some major financial institutions have stepped back from climate-related pledges, an example of which is the recent withdrawal of  money managers, including BlackRock, State Street, JPMorgan and Pimco, from Climate Action 100+ after the group called on members to pressure major corporations to reduce emissions, a plan that withdrawing members said could breach the fiduciary commitment to shareholders or fall afoul of antitrust regulations as the financial institutions acted in concert to shape the behaviors of other companies.

Other retrenchments include decisions by major banks not to pursue a commitment to stop financing new coal mines, to cease publishing the exact energy mix included in investment portfolios, and to renew relationships with states that have criticized ESG-related initiatives. Support for ESG-related policies in proxy voting – once a major arena for activist investors to push sustainable priorities – has dropped significantly as asset managers have become more wary of supporting potentially political initiatives. A study by the Sustainable Investments Institute found that average support for “liberal” shareholder proposals has dropped from 33% in 2021 to 22% in 2023, with the biggest drop in climate-related questions. Investors are also increasingly removing ESG identification from their funds: The third quarter of 2023 was the first time more funds removed ESG mandates from their investment practices than were added, per a study by Morningstar, a reversal from the trend of the last several years when adding ESG criteria to funds reliably boosted investment. The retreat came after investors withdrew more than $8.2 billion from sustainable funds in the first three quarters of 2023, a sharper rate of withdrawal than for conventional funds, which also lost money. Leaders of asset management firms have also dialed down their rhetoric about ESG: In a recent survey by research firm Cerulli, 30% said that they were going to be more circumspect about sustainability-related activities in marketing materials.

The backlash against ESG investing and climate-focused regulations has increasingly spread to Europe, once a leader in ESG regulations. Widespread protests by farmers throughout the EU have been spurred, in part, by sustainability-related protocols that have increased operating costs and reduced profit margins. A French EU lawmaker called the protests in his country “a clear backlash on the agriculture part of the Green Deal,” which included pesticide reduction efforts. The protests come amid a broader pushback on sustainability in the bloc, with EU countries and lawmakers shooting down or weakening new laws on industrial pollution, pesticide use and nature restoration in the past few months. EU officials recently told Reuters that backing for more ambitious green efforts has been eroded by a wave of right-leaning election wins throughout the continent, in which many politicians have cast sustainable initiatives as expensive. The sentiment appears mirrored in the investment landscape: Per a Morningstar analysis, just 233 sustainable open-ended funds and ETFs domiciled in the EU have come to market between January and the end of October 2023, compared to 656 in the same period in 2022.

As a result, the EU appears to be softening some of its upcoming sustainability-related reporting regulations. In July, the EU Commission released an updated draft of its new European Sustainability Reporting Standards (ESRS), aligning European requirements with International Financial Reporting Standards (IFRS). While the stated motive of the adjustment was to ensure international interoperability, climate activists saw the change as a significant softening of reporting standards. The EU is also weighing whether to scrap the fund categories under its Sustainable Finance Disclosure Regulation (SFDR), which require more accurate reporting on the sustainable credentials of different funds, following worries that the more onerous regime has dampened investor sentiment. Meanwhile, the EU voted down the implementation of the Corporate Sustainability Due Diligence Directive (CSDDD), which would have required companies to undertake due diligence to understand and mitigate their climate impacts, at the last moment this week. Once broadly popular, the CSDDD became controversial after Germany indicated that it would abstain over concerns that the directive will be too onerous for businesses. The CSDDD may still pass in a different form, albeit with likely with modifications to make it more business-friendly. Analysts have warned that these trends could continue if nationalist parties win a majority in upcoming European Parliament elections, as many predict they will. Similarly, incumbent European Commission President Ursula von der Leyen has signaled a more business-friendly approach to climate regulations, hinting that she may offer regulatory concessions in a bid to make Europe more economically competitive.

Green Regulations and Sentiment Persist

Despite these headwinds, the EU has largely forged ahead in implementing sustainability reporting standards that lead the global economy. The European Parliament’s SFDR became mandatory in January 2023, and a current open consultation is scheduled to close in July, after which the European Commission may seek to update the SFDR (including potentially loosening fund categories). More companies in the U.S. and Europe will also become subject to Europe’s Corporate Sustainability Reporting Directive (CSRD) in years to come, with reporting requirements coming into force last month for all EU companies (and all U.S. ones with considerable EU presence) that have more than 500 employees. Starting in 2025 and 2026, respectively, reporting will become mandatory for successively smaller entities. Even as sentiment grows less bullish on these regulations, compliance is mandatory.

Although buzzwords like ESG have become lightning rods on Wall Street, there is evidence that sustainability broadly remains popular for consumers and investors. Investment in blacklisted institutions, green infrastructure and transition funds remains healthy. According to an S&P Global analysis, about half of the legislation introduced in “red states” to curb ESG considerations in investing have failed. While green investing continues, investors have shied away from calling it that, focusing on the financial calculus and rarely mentioning a social agenda. BlackRock, for example, the poster child for both an outspoken ESG strategy and the repercussions of that stance, remains committed to sustainable investing. In November, the firm invested $550 million into one of the world’s largest carbon capture projects in Texas, and in January it acquired equity firm Global Infrastructure Partners for $12.5 billion, citing to shareholders the important role that infrastructure reform will play in the green transition.

A poll by pro-sustainability group Unlocking America’s Future found that America’s voters were largely unfamiliar with terminology like ESG, but responded positively to terms like “responsible companies” and “sustainable business practices.” Many major managers also now let individual investors choose what, if any, social values they would like to prioritize in their investing; funds like BlackRock, Vanguard and State Street allow individuals options including “vote with management,” prioritizing religious values, or prioritizing ESG. Many asset managers now emphasize that they are service providers, not policymakers. While sustainable business practices remain attractive to an apparent majority of consumers and investors, the days of C-suite climate leadership may be behind us as public, political, and regulatory sentiment grows more divided.