The Rise and Stall of ESG: A Brief History and A (Hopeful) Look Ahead

Editor’s Note: The following post is based upon remarks given at a recent Across the Board event; click here to view the event video and slides, which also contain citations.

In the past three years, the ESG movement attracted a broad following across corporate America, with a proliferation of related management and investment strategies to advance environmental, social and governance priorities.

But in the past three months, the ESG movement has risked stalling, amid scrutiny revealing the insincerity of vocal proponents, declining levels of both returns and enthusiasm among funds and individual investors alike, and escalating politicization.

What accounts for the rise and stall of ESG and what might we expect in the next three months or three years?

The Rise

Since launching the ESG movement in 2004, the United Nations promoted incontestable aspirations such as to end poverty, hunger, and war and to promote “sustainable” living—defined as using only those resources that are necessary to meet current needs and thereby preserve resources for future generations to meet their needs.

The UN articulated related management and investment principles that came to coalesce around equally virtuous ideas in three categories: environmental, spanning from mitigating climate change to fighting water scarcity; social, encompassing customer satisfaction and assuring fair labor standards; and governance, to assure corporate leadership to advance such goals.

The UN persuaded many managers and investors to follow, especially in Europe but also in the United States. Companies began to create more ecological production and packaging methods, improved their employee training and workplace safety, and appointed sustainability officers. Among investors, many incorporated a company’s ESG commitments into traditional investment analysis, believing that would improve returns; others prioritize social impact as much as financial returns; and some exclude certain businesses they simply regard as un-ESG, such as those involved with alcohol, gambling, guns, oil, or tobacco.

Over the next decade in the US, ESG’s appeal gradually widened into a movement, as the concept of sustainability and the UN’s other virtuous concepts are inherently appealing. The movement was amplified by massive index funds that found ESG to be a useful way to compete in markets where it’s not possible to compete on customer pricing or on investment returns.

In the past three years in the US, the ESG movement intensified due to other powerful social movements such as #MeToo and Black Lives Matter, whose participants seek remedies for grievances of the sort ESG seemed to offer. This intensification was reinforced by eroding trust in American government, worsened by the pandemic, that led Americans to look to the private sector for solutions to economic and social problems.

As such forces gathered strength from Europe to America, they enticed the development of a cottage industry in ESG that has grown so vast it’s now a self-sustaining power, commonly called the “ESG ecosystem.” Millions earn their living through ESG, from framework developers, standard setters and dozens of big data providers to broad coalitions, professional service firms, money managers and an army of NGOs.

During the COVID pandemic, investment dollars began to be allocated to companies ranking high for ESG consciousness, starting in the first quarter of 2020. Investment inflows to ESG funds was greatest among European investors but included a large segment in the US, according to Morningstar data. Those in the ESG ecosystem responded to the demand by increasingly stating specific expectations and priorities and many companies stepped up.

The Stall

Since then, however, interest in ESG investing has declined and several other problems have surfaced that threaten to stall the ESG movement.
ESG investing followed the pandemic’s arc: net investment inflows to ESG funds peaked in the first quarter of 2021, then declined throughout 2022, according to Morningstar. An inflection point occurred in the first quarter of 2023, with a net investment outflow from ESG funds.

Survey evidence explains what the outflow reflects: most individual investors prioritize financial returns over environmental or social benefits.

That inflection point coincided with burgeoning academic literature that increasingly questions the promised value of ESG investing or managing. For instance, a 2022 meta review of all the empirical research—1400 studies—found that “the financial performance of ESG investing has on average been indistinguishable from conventional investing.”

Worst of all for the ESG movement has been the exposure of widespread greenwashing or pinkwashing, vaguely defined colloquial terms referring to allegations of false or fraudulent assertions of ESG fidelity. Such misbehavior has not only helped to stall the ESG movement, its discovery is creating regulatory, litigation and reputational risk for global banks, major companies, and large asset managers.

Concern also arose that the ESG movement was becoming dogmatic, displaying uniform messaging with mandated conduct, some with ideological overtones. Complaints arose that asset managers in corporate balloting vote their personal interests rather than client interests, reflecting a perceived and unwelcome paternalism.

Philosophical frictions surfaced: between those who favor spontaneous coordination through markets over mandates; between sides in a revival of long-simmering debates over corporate purpose—shareholder primacy versus stakeholder theory; and between critics and defenders of capitalism.

With the gap widening between ESG’s original aspirational virtues and these practical realities, ESG fell into a political divide. Dozens of Republican-led states are regulating against using ESG in investment and management while Democrat-led states do the opposite. At the federal level, both the Department of Labor and the Securities and Exchange Commission took sharply different approaches from the Trump administration to that of Biden.

Political activists have seized on the ESG movement to promote rival visions of the social good. Activists increasingly infiltrate corporate meeting rooms, by using the shareholder proposal rule for political ends. On corporate ballots this proxy season are a rising number of politically conservative proposals and a widening scope of politically progressive ones, from civil rights audits to abortion.

What such politicization of the ESG movement portends is uncertain, but for now it is a factor contributing to its stall.

The Future?

Where does ESG go from here? The ESG movement remains powerful but continued oversteps and further politicization risk stimulating greater opposition, not only stalling forward momentum but reversing past achievements. Opponents must likewise remain measured in their critiques, lest they damage their credibility.

Short term, over the next three months, regulators may help cool some of the exaggerations and other passions. They will begin defining and outlawing greenwashing and other ESG misbehavior with a high degree of specificity. That will induce everyone stating ESG expectations and priorities to speak more carefully, curtailing exuberant aspirations and false claims. Such increased caution could restore some of the space for common ground.

Longer term, over the next three years, politics will continue to matter, ahead of and following the 2024 Presidential election. In an ideal environment, vying campaigns would reduce the heat as well, pulling constituents to the center. There is certainly plenty of common ground across corporate America and everyone would benefit if the country can find national leadership who searched for it.

Please feel free to contact Lawrence Cunningham, Special Counsel at Mayer Brown, to discuss further.