The Impact of Uncertainty on Responsible and Sustainable Investing

The article was originally published on the icelandsif.is website, and it can also be found below:

Uncertainty in International Affairs and Its Impact on Responsible and Sustainable Investing

Uncertainty in international affairs has been a dominant force, as conflicts, trade barriers and political tension have become an increasingly decisive factor in relations between states. Conflicts in Europe and the Middle East have increased the likelihood of wider military action worldwide, and the consequences of this uncertainty can be seen in many places.

Uncertainty on the international stage has also affected sustainability and the discussion around responsible investing. Companies and investors have not been spared from the ESG backlash, as there has been a significant shift in emphasis in recent months, including within the EU and under the current US administration. In the United States, rules related to sustainability have deliberately been scaled back or repealed under the priorities of the current administration, while within the EU, criticism of the administrative burden and the pace of implementation of sustainability regulation has fueled debate about corporate competitiveness.

The effects of this on sustainable and responsible investing can be seen in many areas. Many US funds are at a crossroads in sustainability matters, as political risk has increased, along with litigation risk related to investors’ fiduciary duty. Recent examples include lawsuits brought against US asset management firms in which ESG considerations are highlighted and disputed, particularly whether such considerations are consistent with investors’ interests and with the fiduciary duty that fund managers owe to them.

Within Europe, a setback can also be seen when it comes to corporate sustainability disclosure. In recent years, the European Union has placed strong emphasis on improving sustainability disclosure by companies and investors so that decisions are based on reliable and detailed information. Criticism of the EU regulatory framework has led the Union to undertake changes aimed, among other things, at regulatory simplification. One example is the CSRD (Corporate Sustainability Reporting Directive), which has undergone significant changes from its original version, with threshold criteria being raised so that the disclosure obligation now applies only to companies with more than 1,000 employees. This change means that an estimated 90% of companies that were subject to the original disclosure requirement now fall outside the scope of the regulation and are therefore no longer required to disclose information in accordance with the CSRD and ESRS standards. This development is concerning, as many believe it will reduce the reliability, transparency and quality of information.

When decisions are made with regard to ESG factors, decision-makers must ensure that the decision is based on a solid foundation, meaning that the information is accurate, that the relevant risk factors have been identified, and that sufficiently good data is available to ensure transparency and support informed and responsible decision-making. By reducing requirements and disclosure obligations, there is a risk that the basis for decision-making will be weakened and that investors will no longer have access to sufficiently reliable and comparable information to assess ESG risks and opportunities in a meaningful way.

This development may have a direct impact on investors’ ability to fulfill their fiduciary duty, as that duty requires investment decisions to be made with the interests of their clients as the guiding principle and to be based on an informed assessment of all material risk factors. ESG factors can have a significant impact on long-term risk and corporate value creation, for example in relation to climate risk, governance practices or operational risk linked to supply chains, resource use and energy efficiency. Ignoring such factors could in fact be contrary to investors’ fiduciary duty, since that duty involves assessing all risk factors that may affect long-term returns and the stability of investments.

In light of growing uncertainty in international affairs, the importance of taking ESG factors into account in investment decisions is becoming ever greater. Conflicts, political tension, regulatory changes and disruptions in global supply chains can have a significant impact on companies’ operating environment and, consequently, on investment risk and returns. By integrating sustainability and ESG considerations into analysis and decision-making, investors can better identify such systemic and long-term risks, while also recognizing opportunities linked to economic transformation and an increased emphasis on sustainable development. Such an approach supports not only responsible investing but also long-term value creation, as it increases the likelihood that investments are based on a comprehensive assessment of the factors that may affect companies’ future performance and the stability of financial markets.

Author: Heiðrún Hödd Jónsdóttir, Board Member of IcelandSIF and Sustainability Specialist within LSR’s asset management team.