President Joe Biden is keen to make climate change a major theme of his presidency, but for financial markets the impact goes well beyond climate. Investors took note of Biden’s climate plans well in advance of US elections, with renewables and fossil-free assets outperforming the broader market since last summer’s presidential campaign began in earnest. In contrast, markets have paid less attention to social and governance themes in environmental, social and governance investing, particularly around growth prospects for the ESG marketplace in the US.
The Biden administration is certainly eager to promote ESG investing, but there are institutional limits to what can be achieved through direct intervention. Paradoxically, this is one area of financial regulation where the government is likely to pursue a laissez-faire approach. The idea is to remove obstacles to industry trends that are fostering growing ESG integration, building on pension beneficiaries and retail investors’ underlying demand for ESG-aware assets.
So, what can we expect? The Biden administration has already started the rollback of initiatives launched during the Donald Trump years. There had been a push through various regulatory bodies (such as the Department of Labor and Securities and Exchange Commission) to sideline ESG investing by making it harder for asset stewards to incorporate non-financial criteria in their investment selections or in their proxy voting. Other efforts included constraints on bank lending criteria that would have excluded or raised the cost of capital for low-scoring ESG entities.
One of the executive orders issued on Biden’s first day explicitly empowered all regulators in his administration to act to ensure alignment with his overall climate agenda, giving legal grounds for imminent changes. However, these measures would only restore conditions back to 2016 rather than improve on them.
The key actions to watch are those that will actively stimulate the market beyond its current state. Direct regulatory intervention will be the least common as many of the core pillars of investment rules are subject to legislation, notably the Employee Retirement Income Security Act, which dictates the governance of most retirement plans.
Regulatory bodies could provide a more lenient interpretation of fiduciaries’ range of choices and lessen the regulatory burden across the board. A further regulatory impact could come through areas supporting ESG investments, such as guidelines for the development of the ESG ratings industry to help engender common standards. These changes are meaningful but will only unfold incrementally.
In contrast, Biden is likely to use the presidential pulpit and government influence to encourage a swifter deepening of the ESG marketplace. This could occur through shining favourable light on ESG metrics or by promoting ESG-inclusive disclosures. This is already happening on climate-related issues and is likely to spread beyond this once most of his political appointments are in place.
These efforts could be complemented by joining or co-operating with various international forums, such as the international platform for sustainable finance which includes most members of the Organisation for Economic Co-operation and Development as well as China and India. The Biden administration can directly affect the allocation of federal asset pools (federal retirement pools like Thrift Savings Plan), and therefore provide another tailwind to the growth of ESG investing inside the US.
The reality is that ESG investing is following a powerful structural trend, which was accelerated by the Covid-19 pandemic. 2020 witnessed another boom year for growth in sustainable investing. In the fourth quarter alone, global inflows were up 88% and amounted to $152bn. However, the bulk of that growth remains overwhelmingly in Europe with the US only accounting for about one-eighth of inflows.
This suggests there remains great potential for rapid catch-up that was presumably deterred by the Trump administration. Despite the institutional constraints for major reforms, ESG investing will now enjoy policy and regulatory tailwinds in the US. This could even lead to a temporary mismatch in supply and demand of ESG assets in the US. Corporate pioneers could benefit from lower cost of equity and European funds could attract US inflows on the appeal of their ESG scoring (with the understanding that ESG scores and assessment vary widely).
Like the environment, the climate of finance is changing. While it may seem like a slow evolution, all participants need to adjust as quickly as possible.
Elliot Hentov is Head of Policy and Research at State Street Global Advisors.