In recent years, Morningstar’s Sustainability Atlas has consistently placed European countries including the Netherlands, Finland, and Sweden at the top of its global rankings on environmental, social, and governance (ESG) practices. Meanwhile, the United States has lagged slightly behind, ranking 13 out of 48 in the most recent analysis.
As the European Union attempts to consolidate its position as a sustainable leader with an ambitious agenda to combat global warming, US investors face a number of regulatory challenges on ESG. What would it take to level the playing field?
EU and US Take Diverging Paths on ESG Investing
Sustainable investing is a key priority for the EU. The European Commission (EC) has announced its ambitious European Green Deal as well as a binding commitment to attain climate neutrality by 2050. The associated EU Taxonomy will require financial services firms with business in the EU to report how certain products fare in terms of environmental sustainability. Considering these regulations and growing demand among institutional investors, researchers predict that sustainable assets in Europe could triple by 2025, accounting for over half of all funds.
While the EU has legally committed itself to long-term climate neutrality, the direction of travel for the US appears more nuanced. Although sustainable investing has continued to gather momentum among US investors, recent challenges by the US Department of Labor (DOL) and Securities and Exchange Commission (SEC) sent fresh shock waves through the US ESG investment world. For example, a 2020 change to SEC shareholder proposal rules limits investor eligibility to file resolutions at corporate annual meetings. The change has raised concerns that it will dissolve pressure on US listed companies to improve their standing on ESG issues. The SEC is also considering new requirements dictating how financial services firms label investment products as ESG or sustainable.
Catching up with the EU will require the US to take more decisive action in favor of ESG investing, as the EU has done with its Taxonomy. Many expect the Biden administration to bring renewed openness toward climate change mitigation and other sustainability initiatives. Biden’s $2 trillion climate plan targets a wide range of sectors, from infrastructure and transportation to energy and agriculture. Biden began laying groundwork for a commitment to climate with multiple executive actions in the first week of his presidency.
At the same time, ESG investors in the US are continuing to raise their voices on sustainability issues. The DOL’s 2020 proposal of a final rule limiting retirement funds governed by the Employee Retirement Income Security Act (ERISA) from incorporating ESG strategies saw significant backlash, and in March 2021, the DOL announced that it would not enforce the controversial guidance. The SEC’s decision to limit shareholder proposals has precipitated vocal resistance as well.
US investors are also using their capital to illustrate the growing demand for ESG investment opportunities and a regulatory framework that accommodates them. According to Morningstar, net flows of US sustainable funds hit $51 billion in 2020, a near ten-fold increase from 2018.