Key Impact Points:

• ESG label is being dropped for “sustainability” due to political pressure.
• Investment in energy transition hit a record $1.8 trillion in 2023.
• ESG funds in the US see significant outflows, with $8.8 billion withdrawn in Q1 2023.

The red carpet is being rolled up for ESG (Environmental, Social, Governance) on Wall Street. Institutional Investor (II) has replaced the term “ESG” with “sustainability” in its annual analyst rankings, reflecting a broader trend amid the increasingly politicized debate over climate change and corporate diversity in the US.

Shifting Narratives in Financial Firms

Michael Karp, who runs recruitment firm Options Group in New York, observes: “Banks aren’t all in like they were during the boom days.” This shift reflects the financial sector’s cautious stance to avoid backlash from oil-rich red states while maintaining appeal in blue states and Europe, where ESG remains influential.

At stake is more than just terminology. Recent extreme weather events like the historic hurricane that hit Texas and wildfires in California underscore the urgency of addressing climate change. This has spurred demand for niche ESG investments, such as climate-transition funds and catastrophe bonds, with global investment in the energy transition rising 17% last year to a record $1.8 trillion. The US alone saw “strong growth” in 2023, spending $303 billion, according to BloombergNEF.

The Changing Role of ESG

However, the narrative around ESG has shifted. Some firms like Neuberger Berman remain committed, but others are stepping back. Jefferies Financial Group Inc. has replaced ESG with “sustainability and transition” in job titles. Wellington Management Co. and Lazard Asset Management have reduced their ESG staff, while Bank of America Corp. merged its ESG team with clean energy initiatives.

Bank chiefs, once vocal about “net zero” emissions, continue to engage with fossil-fuel companies. Investment giants like State Street Global Advisors have distanced themselves from climate action groups, and mentions of climate change and DEI (diversity, equity, inclusion) are now rare in company calls.

Financial and Political Challenges

ESG faces significant challenges, including a climate rule from the SEC being contested in courts and the Federal Reserve’s resistance to making environmental risks a global financial focus. The potential for a second Trump administration, hostile to climate initiatives, adds to the uncertainty.

Financial performance is also a factor. The S&P Global Clean Energy Index has dropped over 50% since early 2021, even as the S&P 500 reached record highs. Consequently, US ESG funds have seen outflows, with assets dropping to around $335 billion from nearly $365 billion at the end of 2021, according to Morningstar Inc. Investors pulled a record $8.8 billion from these funds in Q1 2023, marking the sixth consecutive quarter of outflows.

Commitment to ESG Principles

Despite these headwinds, some US firms remain dedicated to ESG. Jim Coulter of TPG Inc. and George Walker of Neuberger Berman continue to emphasize its importance. Walker highlights the imprecise use of ESG, creating a perception of political agendas, but insists it is essential for managing financially material risks.

Alison Taylor, who teaches sustainability at NYU, warns: “If we don’t have ESG, company valuations will be bumpy and there could be events that drive companies out of business.”

While the term ESG may be in decline, the principles behind it continue to influence investment decisions and corporate strategies. The industry’s evolution reflects ongoing tensions between financial performance, political pressures, and the urgent need for sustainable practices.