Europe maintains steady investor demand amid US-led ESG backlash

ESG has a robust regulatory framework in Europe, including the European Union taxonomy, which defines climate-friendly investments

Europe’s steady investor demand for environmentally and socially responsible investments and extensive regulation are helping Europe’s financial sector withstand the political pressure that has pushed some U.S. peers to return to their green agenda.

In the United States, conservative politicians have been successful in restricting environmental, social, and governance (ESG) product marketing, diluting regulations that promote ESG disclosure, and discouraging financial firms from to coordinate efforts to reduce greenhouse gas emissions.

But Europe has largely resisted the anti-ESG tide so far, thanks to greater political and consumer support for greener products and a raft of regulations that support the activities of the financial sector and companies in the real economy.

Some politicians in Europe have been active in relaxing environmental regulations and legislation, highlighting the consumer costs of going green.

This has led to the dilution of a number of new regulations promoting ESG in Europe. But the fund flow data shows that, overall, Europe is still an ESG stalwart.

European investors have seven times as much capital in sustainable fund assets as US investors, after five consecutive quarters of US outflows, based on Morningstar data.

“We have seen that faster regulation has led to faster compliance, which has protected European financial institutions from ESG headwinds,” said Nathan Abela, head of research at sustainability data tracker ESG Book.

Across the European financial services industry, there are 20 rules and 25 voluntary guidelines related to ESG, compared to just two rules and five voluntary guidelines in the United States, according to ESG Book.

There is also greater investor demand for ESG in Europe, driven by public pension funds. About 73 percent of European pension plans said climate change was an investment priority in 2023, compared to 53 percent of U.S. pension plans, based on a 2023 LSEG survey.

The commitment of European financial companies to ESG could be crucial for the survival of international climate alliances.

Initiatives such as Glasgow Financial Alliance for Net Zero (GFANZ) and Climate Action 100+ have led to US defections.

companies, but their European membership has remained largely intact.

This is important because most of their members are European. For example, one of the GFANZ coalitions, the Net-Zero Banking Alliance, has 71 European members, but only nine from the US. The Net-Zero Insurance Alliance has eight European companies as members, but none from the United States.

ESG has a robust regulatory framework in Europe, including the European Union taxonomy, which defines climate-friendly investments. Other important EU rules include the Sustainable Finance Disclosure Regulation, which forces financial groups to disclose their sustainable investments, and the Corporate Sustainability Reporting Directive (CSRD), which applies to companies in the real economy.

Furthermore, people in Europe tend to be more united in their support for climate action.

A 2022 survey from the nonprofit Pew Research Center found that Europeans, regardless of political background, were more likely to view climate change as a “major threat.” In the US, the survey found that there are deep divisions over climate views between people on the right and left of the political spectrum.

“There is disagreement in the EU or in Europe about the importance of this (ESG), but the disagreement is not as great as in the US,” says Kamiar Mohaddes, associate professor of economics and policy at Cambridge Judge Business School.

But Europe has not been immune to attacks on ESG regulations. CSRD and a separate law aimed at ensuring companies’ supply chains are environmentally friendly and protect human rights have been amended in the past year to cover fewer companies and allow more time to comply.

There has been a dent in European investor demand for ESG, but it has been small. Launches of new ESG funds fell by 10 percent in Europe in 2023, but in the United States the decline was even more pronounced, with a decline of 75 percent, according to Morningstar.

U.S. outflows from SRI funds reached $5.1 billion in the fourth quarter, compared to $3.3 billion in inflows into Europe, making European assets under management seven times larger than those in the United States.

“What we’re seeing in Europe is that everyone remains quite focused on ESG and the way it’s being implemented,” said David Zahn, head of sustainable fixed income at asset manager Franklin Templeton.

However, Zahn said ESG is not investors’ only concern.

“It’s not just ESG they care about. They want to see portfolios that take ESG into account, which may have some limitations, but they also want performance.”

First print: April 12, 2024 | 11:49 am IST