The ‘Kodak’ moment for the asset management industry has arrived. A new Strategy& study describes how the ESG trend in investing is gathering incredible momentum of its own, catalysed by EU regulation designed to make Europe the first-climate-neutral continent by 2050. While true leaders will take advantage and make strategic choices to navigate through the ESG jungle now, laggards will risk no longer being able to see the wood for the trees.
This year has been dominated by a lot of negative headlines related to COVID-19. But one promising development has been the increasing relevance of ESG (environmental, social and governance) factors in asset management. More and more investors, institutional and private, are considering the impact of their investment decisions.
This observation is backed up by hard figures. By 2019, total investment in sustainability-focused investment funds and mandates had increased to around CHF 610 billion, with private investment growing to CHF 270 billion in Germany, Switzerland and Austria (GSA). So far, this increase has largely been driven by the Swiss market, which accounted for about 75% of ESG investments in GSA in 2019. Between 2017 and 2019, institutional ESG investment in the German-speaking countries tripled, and private ESG investment quadrupled. These figures come from a new study prepared by us at by Strategy&, PwC’s strategy consulting arm: Finding a sustainable path through the ESG jungle.
It’s down to regulation. But not just regulation.
Regulation, especially prospective EU regulation around the European Green Deal – a huge initiative aimed at making Europe the first climate-neutral continent by 2050 – is certainly playing a part in catalysing this mushrooming in demand for ESG investments. But it’s by no means the only driving force. The fact is, ESG investments are turning out to be intrinsically more attractive, in many cases outperforming traditional investments, and receiving record inflows. Many investors also associate ESG with a superior risk profile.
But let’s get back to the EU Commission’s European Green Deal. In 2021 and the years that follow we’ll be seeing new EU regulations on ESG designed to make the deal happen. The target is to increase the volume of sustainable private investments to EUR 260 billion per year by 2030.
These EU regulations will fall into three main categories: 1) an EU taxonomy, providing a standardised framework for defining and classifying activities promoting a low-carbon economy; 2) sustainability disclosure rules requiring asset managers to reveal how they integrate ESG in their risk management and investment decisions; and 3) benchmark legislation to cater to investors wanting to pursue a climate-focused strategy. The new rules will create significant incentives for private investors to allocate capital to financing sustainable projects, with obvious spill-over effects for Swiss investors and industrial corporates operating on the European market.
Another key driver of growth in ESG investment is new alliances and initiatives on the investor side. These include the Net-Zero Asset Owner Alliance, which brings together pension funds and insurers that collectively control assets worth USD 5 trillion, and the Partnership for Carbon Accounting Financials, which now comprises global financial institutions with more than USD 5.3 trillion in assets under management. These will inevitably lead to major portfolio shifts.
Three scenarios for ESG investment: big, bigger and enormous
It’s clear that the development of the ESG investment market will depend to a significant extent on the interplay between regulation and intrinsic motivation on the part of investors. Taking this into account, for the study we assessed three different ESG growth scenarios for Germany, Switzerland and Austria.
The first scenario assumes that the final EU sustainable finance regime leaves enough opportunities and incentives to continue traditional investment strategies, and that as a result ESG continues to make up around 15-20 percent of total assets under management by 2024. In this scenario, ESG funds and mandates are worth EUR 1.2 trillion by that point.
The second scenario assumes that the new regime provides strong incentives for institutional investors to shift towards ESG, plus continuing public pressure for a wider range of investment products closely aligned with the EU taxonomy. In this case, ESG’s share of total assets under management would reach around 30 percent by the end of 2024, for a total of EUR 2.1 trillion.
The third scenario – and this is where it gets really exciting − assumes that the new regime compels institutional investors to shift towards ESG investments. This would result in faster growth in ESG. In this scenario, up to 55 percent of assets under management would be held in ESG-focused investments, with ESG funds and mandates worth EUR 3.8 trillion (more than CHF 4 trillion!) by the end of 2024.
Implications for asset managers
Given that even the second scenario has such significant implications for asset managers, we believe that they now need to decide how they want to play it. Do they intend to merely comply with the regulatory minimum? Or do they plan to build a leading ESG offering with a corresponding upgrade of their investment products?
Our experience shows that the journey is multi-dimensional, spanning everything from strategic positioning, products, risk appetite and management, reporting and reducing the carbon footprint of your own operations, to winning the hearts and minds of your employees and embracing a visible ESG culture. It’s a complex undertaking, but there’s an enormous upside − as well as a serious downside.
As we said before, the Kodak moment for the asset management industry has arrived. Do you want to take the reins and proactively harness the opportunities? Or the alternative?