Why Everyone’s Talking About… ESG Backlash

Not so long ago, enthusiasm for sustainable investing was on a seemingly unstoppable upward trajectory. Since 2023, however, the ESG theme has experienced turbulence on both sides of the Atlantic. So, is this disenchantment temporary – or is it here to stay?

Faced with the risks posed by global warming and biodiversity loss, and under pressure from public opinion and increasingly alarming scientific reports, governments have implemented ambitious public policies. The US launched the Inflation Reduction Act and the European Union unveiled the Next Generation EU.

Prior to these stimulus packages, the EU had already pushed through the Paris Climate Agreement (2015) and the Kunming-Montreal Global Biodiversity Framework (2022) a part of the Green Deal and the Nature Restoration Law. This regulatory and political context has created an appetite for climate- and biodiversity-friendly investments, including ESG (environmental, social, and governance) investments.

ESG-labelled funds aim to invest in companies or assets that demonstrate strong ESG practices and are aligned with certain sustainability goals. These have been met with growing interest from investors, demonstrating their resilience during the pandemic due to their underweighting to the energy sector¹. In Europe, flows into ESG funds ballooned to €233 billion in 2020 from €126 billion the year before¹.

But the brakes came on in the immediate aftermath of Russia’s invasion of Ukraine. The resurgence of inflation, fuelled in part by soaring energy costs, triggered a rapid and lasting rise in interest rates that penalized investment in the highly capital-intensive and subsidy-intensive energy transition – the shift from fossil fuel-based energy sources, such as coal, oil, and natural gas, to renewable and low-carbon energy sources, such as solar, wind, hydro, and geothermal power. This was particularly true of offshore wind power, exemplified in the difficulties encountered by the Danish windfarm Ørsted and the Swedish energy giant Vattenfall .

At the same time, many European countries that had traditionally been weaned on Russian gas decided to secure their energy supplies by resorting to Liquefied Natural Gas (LNG), often imported from the US or Qatar. The message was clear: energy security trumps environmental concerns.

Since then, European governments – whose debts accounted for 89.9% of GDP as of Q3 2023³ – have realised they can’t afford to remain outside the Stability and Growth Pact forever⁴. After being suspended in March 2020 in the wake of the Covid crisis, European budgetary rules were re-applied in January 2024. And the outlook for Europe suggests growth will be sluggish for the foreseeable future⁵ – around 0.5% of expected GDP growth in 2024 following 0.5% in 2023, raising the prospect of a return to fiscal austerity.

In March 2024, France was forced to make budget cuts of €10 billion, including €2 billion for the environment, due to a lower-than-expected growth forecast. Other European countries, such as Germany and Italy are making similar cuts⁶. These short-term trade-offs compromise the chances of success of a transition that requires massive, long-term investment. According to the Rousseau Institute’s 'Road to Net Zero' study, Europe needs to invest €1,520 billion a year to reach the 'net zero' target by 2050⁷.

And when the geopolitical and financial context is combined, it explains the so-called ‘ESG backlash’ on both sides of the Atlantic. The immediate result is that climate ambitions are on the wane, in both the investment and political spheres.