Unlocking the Future of ESG Investments

Over the past year, we’ve seen governments and business leaders take meaningful steps to reduce greenhouse gas emissions and meet  sustainable development goals. And in support of these actions, we’ve also seen a rise in the use of environmental, social, and governance (ESG)  funds and products.

While the ESG market continues to flourish, it’s also important to consider the potential impacts of economic turbulence and geopolitical events on the green transition. KPMG’s latest Asset Management Opportunities and Risks report offers insights from Canadian asset managers on where they see the future of ESG heading in the next 12 months.
Interestingly, product demand for ESG remains high. Nearly all of the asset managers surveyed offer ESG strategies to investors, and in fact, ESG was tied for first place (along with alternatives) as the strategy most in demand by investors. As for institutional investors, over half of them have identified ESG products as one of their top focus areas.

It’s clear that ESG is here to stay, and as the world becomes more aware of the need to protect the environment and support social causes, it’s likely that demand for these types of investment products will only continue to grow.

In the race to label products as ESG-aligned, questions have emerged about the definition, measurement, and comparison of ESG standards. This has raised concerns among investors and regulators about the potential for “greenwashing” – misrepresentation of environmental and social responsibility in ESG products. As a response, securities regulators in North America have proposed rules and guidance on ESG labeling and disclosures, and ESG-related comments have overwhelmingly dominated regulatory discussions on a share offering prospectuses in Canada over the past year.

Asset managers are under pressure to ensure that their ESG products deliver genuine environmental, social, and governance outcomes that meet regulatory standards. However, without clear guidance on measurability and comparability of ESG criteria, asset managers are exposed to risks in an ESG market that is outpacing regulation and legislation. The sale or marketing of products that do not meet future mandated criteria could have disruptive effects on asset managers, from regulatory implications to client losses.
As we move towards more climate-aligned strategies, we must acknowledge that the transition to clean energy cannot happen overnight. One of the biggest challenges for asset managers offering ESG products is the lack of investable opportunities in the market.

The traditional approach of divestment from high carbon emitters has limitations, as it may lead to “dirty capital” from unregulated sources filling the gap. A new trend is emerging where large institutional investors are establishing high carbon transition funds that actively invest in carbon-intensive assets with legitimate decarbonization strategies. This approach not only enhances investment returns but also contributes to real economy emission reductions.

As they work to fulfil their ESG responsibilities while providing value to stakeholders in a competitive market, investors are expected to commit to more asset allocation decisions in the upcoming months. It is essential to manage the imbalance between demand and supply for ESG-positive investment opportunities carefully, and this approach may offer a viable solution.

New generations of asset managers are confronted with unfamiliar issues as the financial sector undergoes inflationary pressures and interest rate increases akin to those observed in the 1970s. They must also handle the possible effects of future business valuations on global climate policies. This calls for a prudent approach to ESG investments and climate-themed products and funds, ensuring a clear understanding of how underlying investments will react to higher interest rates and continued high inflation.

For firms launching new ESG products and funds, it’s crucial to stay ahead of the game and evaluate rapidly evolving regulatory environments. At KPMG’s Asset Management team, we understand the need for effective ESG strategies, tax consultancy assistance, and regulatory analysis to help businesses and investment portfolios stay competitive.