ESG: rebranding or fundamental shift?

What you need to know

• The use of the term “ESG” is in decline. While ESG-related principles continue to remain an important aspect of operations for many stakeholders, there have been signs of a shift in the ESG landscape when it comes to the investing in, and management of, private market funds, with many institutional investors replacing the ESG acronym with terms such as “sustainable” or “responsible” investing.
• Efforts are underway to standardize sustainability reporting. A lack of universal metrics for ESG initiatives has led to a perception among some that ESG reporting lacks credibility and might result in giving up a strong return profile. Both in Canada and abroad, efforts are underway to standardize sustainability disclosure, with guidance expected to come into effect in 2025, signalling that some sort of sustainability metrics are here to stay.
• A recent U.S.-based rise of “anti-ESG” legislation leaves fund sponsors at a crossroads. Over the past several years, certain American legislatures have passed “boycott legislation” prohibiting fund managers from considering ESG factors in their investments, leaving fund sponsors to question whether creating an ESG policy one way or the other might limit their investment opportunities.

Changing attitudes towards ESG

In our article from just one year ago, “Fund sponsors juggling ESG in private market investing”, we discussed the challenges that fund sponsors were facing in navigating the rise in, and variation of, investor requests relating to ESG-related considerations.

Since that time, many fund sponsors and institutional investors have had the chance to further adapt their internal views and policies, and while ESG-related principles continue to remain an important aspect of the operations of many such stakeholders, there have been signs of either a rebranding or a shift in the ESG landscape when it comes to the investing in, and management of, private market funds.

While this is particularly pronounced in the United States (given the U.S.-based controversy, politicization, and polarization of ESG), it is happening on a global scale.

Use of the term in decline

By way of example, at its peak in Q4 of 2021, ESG was mentioned in 156 earnings calls for companies on the S&P 500, which fell to only 74 S&P 500 companies mentioning ESG in earnings calls in Q2 of 2023. More recently, the U.S. Securities and Exchange Commission released their 2024 examination priorities, and many were surprised that ESG did not make the list for the first time since it was added in 2021. While the foregoing are not specific to private market funds and their portfolio companies, they provide concrete examples of how ESG—as a term or as a concept—is falling off the radar.

Below we discuss a few developments that may be contributing to the decline in the use of ESG (whether in term or in concept) by fund sponsors and institutional investors alike.

Getting the metrics right

As references to ESG in earnings calls peaked in 2021 and 2022, so did the perception that ESG lacked fair, universal metrics. Many public and private stakeholders have struggled to make clear progress among a number of competing standards, frameworks and initiatives. This lack of standardization has led to a perception among some that ESG reporting lacks credibility and may result in giving up a strong return profile. Initiatives are currently underway in Canada and globally to standardize sustainability reporting.

For instance, on March 13, 2024, the Canadian Sustainability Standards Board (CSSB) published two exposure draft standards for sustainability reporting, which are currently open for public comment and are projected to come into effect January 1, 2025¹. These drafts follow closely the IFRS Foundation’s International Sustainability Standards Board (ISSB) guidance published on June 26, 2023, and will guide the Canadian Securities Administrators (CSA) process of drafting the first mandatory climate-related disclosure rule in Canada². These developments mark significant progress in standardizing sustainability disclosure and therefore improving fairness, universality and credibility—and they signal that some sort of sustainability considerations and metrics are here to stay.

Becoming part of the ordinary course

Another possible reason for the decline in the use of the term “ESG” is that it has been folded into some fund sponsors’ and institutional investors’ broader policies, diligence, investment decisions and processes—and therefore it is becoming increasingly framed as a part of investment considerations and less so as a standalone concept. The decline in use of the acronym may give the perception that ESG priorities are decreasing, when it is merely getting broken up into parts and embedded into day-to-day investment processes as a risk-management tool to identify, evaluate and mitigate financial, operational, regulatory or reputational risks.

Political controversy

The politicization in the United States that has specifically surrounded the term “ESG” may have led to a rise in fund sponsors—and institutional investors—replacing the ESG acronym (in their policies, programs, department names, job titles, etc.) with perhaps less controversial or polarizing terms such as “sustainable investing” or “responsible investing”, while these programs and priorities remain largely the same (one institutional investor recently joked to us that at this point it should just be called “investing”).

For instance, over the past few years, in the United States there has been a rise in anti-ESG and boycott legislation which prohibits fund managers from considering ESG factors in their investments and prohibits state entities from investing with managers that “boycott” investments related to specific industries, such as oil and gas. Therefore, fund sponsors reach a crossroads: do they want to attract investors who are focused on ESG metrics, or do they want to attract investors who are explicitly not focused on ESG metrics? They will not always be able to attract both. Similarly, institutional investors need to decide if creating an ESG policy one way or the other could limit their investment opportunities.

Final thoughts

It remains to be seen whether the movement away from ESG is rooted in terminology—i.e., that it is undergoing a “rebranding”—or, whether the movement away from ESG is actually a fundamental shift away from the concept as a meaningful metric in investment considerations. While we suspect it is likely a hybrid of the two, factors like political headwinds and broader market activity will be indicators of how the rest of the ESG story unfolds for private market investors and fund sponsors.