Sustainable investing beyond ESG

Since German prosecutors raided the DWS-offices last year because the subsidiary of the Deutsche Bank was greenwashing investment funds, the appeal of the ESG-concept embraced in the past 15 years by the financial sector is rapidly vanishing. Nothing to feel sorry about, as this opens the way for the financial sector to take decisive steps to play a leading role in the sustainable transformation of the global economy.

Some 15 years ago, the increasing attention for ESG in the financial sector promised to be an important step forward. ESG refers to integrating Environmental, Social and Governance factors in investment and financing decisions. Overlooking these issues can contribute to greenhouse gas emissions, human rights’ violations, biodiversity destruction and all kind of other negative impacts. Integrating ESG-factors was the response of the financial sector at the time when various NGOs in the UK, US, Germany and the Netherlands began to hold banks to account (often based on Profundo research) on the destructive impacts of their financings of, among others, fossil fuel and palm oil companies. This pressure led to the establishment of the Equator Principles in 2003 and the Principles for Responsible Investment (PRI) in 2006. The PRI aim “to understand the investment implications of environmental, social and governance (ESG) factors” and to help “signatories in incorporating these factors into their investment and ownership decisions.”

The PRI in the first place aimed to address the reputational impacts which ignoring ESG-factors could have on investors. This risk was clearly demonstrated in 2007 by the notorious Zembla television documentary “The Cluster Bomb Feeling”. It showed, based on Profundo research, how Dutch pension funds were involved in cluster munitions, environmental destruction, and child labour. The documentary caused a public outrage for months, that resonated far beyond the Netherlands. After many similar media and NGO revelations in the following years, banks and investors across the world learned to understand the relevance of managing the impact of ESG-factors on their reputations. They massively started hiring ESG-managers and -analysts, who wrote all kinds of ESG-policies and developed ESG-investment products, supported by a whole new industry of ESG-rating agencies.

Fast forward to 2023: ESG is everywhere now in the financial sector. The PRI has more than 5,000 members, representing by far the majority of all assets under management globally. All global banks have “ESG-risk” departments and investors can choose from thousands of ESG-investment funds, branded as “green”, “sustainable”, etc. Even financial regulators are warning about the impact of ESG-factors, including climate change and biodiversity, on the financial system.


Unfortunately, the rise of ESG has not resulted in massive positive real-life impacts. Admittedly, some of the worst companies had to change their plans, because banks and investors became more cautious to put their money into activities that could hurt their reputations. The positive impact of these steps on society remained more of a by-product, however, than really the core objective. Although many people within the financial sector made it appear differently.

But we are entering a new phase now. Since the German police raided the offices of DWS in May 2022, accusing the investor of greenwashing its investment funds, the whole ESG-bubble is rapidly deflating. Scientific studies conclude that the ratings of ESG rating agencies are not consistent and that the ESG expertise of financial institutions has been greenwashed as well. Media reports show that ESG investment funds continue to invest in airlines and fossil fuels. Financial regulators conclude that banks don’t do enough on climate change. And in our own studies, Profundo concluded time and again that banks, insurers and pension funds do not take sufficient action to ensure that the companies in their portfolios respect the ESG-standards of the financiers.

Meanwhile, ESG is also under fire for completely different reasons in the United States. Funded by a libertarian billionaire, Republican politicians in several states are proposing anti-ESG legislation to force investors to continue investing in fossil fuels.

Why ESG did not work

Leaving this political demonization of ESG aside, there are a few key reasons why the ESG-concept has hardly contributed to the sustainable transformation of the global economy:

  • The increased attention for ESG-risks was never intended to make the world more sustainable, but to prevent reputational damage and manage the financial risks of stranded assets (e.g. coal-fired power plants which have to be closed).
  • Most financial institutions still are reluctant to prioritize contributing to sustainable transformations, because of the consequences for their business models and disproportional profits. Meanwhile, their marketing departments pretend they already have embraced sustainability – which results in greenwashing.
  • In a further effort to have their cake and eat it too, most banks and investors have never developed evidence-based strategies to make their portfolios more sustainable. Roughly, the two options are encouraging the companies already in their portfolios to change (“engagement”) or shifting capital to other companies which are serious about sustainability.  Most financial institutions dogmatically advocate the first strategy, although they do not commit the resources to seriously engage with the thousands of companies in their portfolios.
  • Financial regulators did also not steer the financial sector towards more sustainability, as they have only recently discovered this new task. The Network for Greening the Financial System plays a pioneering role, and the ECB now takes position as well. But there is still a long way to go before regulators realize that this new role requires alternative models for financial risk management and portfolio compositions.

Define sustainable financing and investment

Within this context, there is an urgent need to move beyond the confusing and misdirected ESG-concept and define what sustainable financing and investing needs to be. Here are four key elements:

  • Banks and investors should embrace the objective of contributing to a more just and sustainable society in their mission – rather than protecting their own reputation against civil society’s criticism.
  • This new mission requires an effective strategy to convince the companies in their portfolios to reinvent themselves, creating sustainable products and production processes. Engagement can play a role in this strategy, but requires sufficient efforts and time-bound goals. This is only achievable when investors choose for more concentrated portfolios, allowing them to really understand companies and provide them guidance. 15 years after the Zembla-documentary, some of the largest Dutch pension funds (ABP, PME and PfZW) are now taking this logical step – hopefully more investors will follow their lead!
  • In the transformation towards a more sustainable economy many companies and even entire sectors (such as the oil & gas industry) will have to dissolve, freeing up manpower, creativity and capital for new developments. Banks and investors should encourage this process by actively shifting capital to start-ups, cooperatives and relevant projects that operate in a sustainable way and offer transformative products and services. Financial expertise should be be used to let such sustainable initiatives flourish, instead of maximizing the revenue streams of financial institutions.
  • Financial regulators should encourage this transformation of the financial sector by radically rethinking their old risk management models and regulatory guidelines, instead of focussing on the disclosure of ESG-information which does not encourage companies to rethink their business models.

The collapse of the ESG-concept is nothing to feel sorry about, as it might encourage more financial institutions and regulators to take decisive steps in the directions of sustainable financing and investment.

Jan Willem van Gelder, director Profundo

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