Europe in pole position for ESG transformation, but opportunities not fully leveraged

Brussels, 12 November 2020 - In its latest report, “2022 - The growth opportunity of the century”, PwC quantifies and assesses Europe’s dominance in the global ESG sphere and identifies four key catalysts driving the sustained growth of ESG: regulation, the outperformance of ESG funds, growing investor demand and societal shifts. The report found there’s an urgent need for asset managers to embark on full-scale ESG integration both within their business strategies and their operations.

Europe in pole position

In Europe alone, PwC expects ESG fund assets under management (AuM) to account for over 50% of total European mutual fund assets by 2025. This will represent a staggering 28.8% compound annual growth rate (CAGR) from 2019 to 2025. PwC forecasts European ESG assets to reach between EUR 5.5 trillion and EUR 7.6 trillion by 2025, making up between 41% and 57% of total mutual fund assets in Europe by 2025; up from 15.1% in end-2019.

Marc Daelman, Partner at PwC Belgium said: “While ESG is considered a rapid and significant development, many managers still see it as just another product. However, ESG is nothing less than an all-encompassing shift in the investment landscape, placing financial and non-financial performance criteria on a level playing field. As the European Commission noted, the scale of investment needed to transition to a sustainable and green economy is beyond the capacity of the public sector alone. Asset managers can change the world for the better by rechannelling capital towards sustainable businesses and innovations, contributing to the creation of a low-carbon, climate resilient and circular economy and strengthening efforts to eradicate social injustices across the globe.”

Regulation: policymakers accelerating industry shift

Arguably the primary differentiator which cements Europe as the global leader in the ESG space is its strong regulatory and legislative structure. Both the EU Action Plan and the sustainable Financial Disclosure Regulation (SFDR) represent a landmark change in the industry, that stand to transform sustainable finance from an optional consideration to a focal point of the European fund industry. From 2021 onwards, a range of new regulations will be introduced, and pre-existing regulations will be altered to aligns with sustainability requirements.

“We have seen a major shift from voluntary regulations and initiatives to rigid and binding legislation. As the regulatory landscape develops, unsustainable corporates will lose out on capital and non-compliant sectors will be penalised as a result. The anticipated new regulation will introduce a whole new set of non-financial standards for investors, financial advisors and financial market participants. Change is coming and the industry must adapt to not only comply but thrive in this new landscape where sustainable investment is no longer optional, but mandatory”, commented Marc Daelman.

ESG outperformance: the gap widens in the future

PwC analysis shows that ESG-aligned funds cumulatively outperformed their traditional counterparts by 9% over a period from 2010 to 2019. COVID-19 has further highlighted the performance of ESG funds through stressful market periods. While traditional asset classes suffered near-unprecedented outflows in Q1 2020, the financial impact of the pandemic was not felt as strongly in the ESG space, with ESF funds outperforming the broader market. This was also conformed by a Bloomberg analysis finding that the average ESG fund declined by 12.2% in 2020, less than half the decline of the S&P500.

“We believe this performance gap between ESG and non-ESG products will widen significantly in the future. The long-held concern of ESG products’ tendency to underperform will reverse entirely, with these products emerging as a stronger source of returns with respect to their mainstream equivalents. Already, the European Investment Bank (EIB) has transitioned towards a climate bank model citing performance concerns, suggesting that this shift may be well underway”, says Marc Daelman.

Surge in investor demand leaves the industry with no choice

Investors are leading the green revolution, demanding that asset managers allocate capital in a sustainable manner. While both retail and institutional segments are showing fast increasing interest in sustainable investment, institutional investors are leading the charge. Our survey shows that 99% of institutional investor respondents expect a convergence between ESG and non-ESG fund products, with an overwhelming majority expecting this to occur by 2022. The retail investor segment lags behind but is catching up fast. Currently only 41% of retail investor respondents incorporate ESG considerations into their investment strategies.

“As the millennial generation becomes more active, retail investors are likely to take up the ESG mangle. They are set to be on the receiving end of a record-breading USD 41 trillion intergenerational wealth transfer and 95% are interested in sustainable investing. This new generation of investors stands to vitally reshape the future of investment”, said Marc Daelman.

Rapidly shifting societal values highlighted

Global discourse has shifted in recent years, marked by a growing recognition of the threats that could materialise if ESG and sustainability issues continue to be overlooked. ​ The COVID-19 pandemic and subsequent market downturn will catalyse the shift in society’s awareness of ESG issues. 97% of respondents stated that the pandemic will impact their ESG approach in the future.

“The game changer in 2020 has obviously been COVID-19. In the aftermath of the pandemic, we wouldn’t be surprised if regulators choose to intensify their scrutiny on the ways in which ESG risks are integrated in the investment process. The asset and wealth management industry has so far played a key role in mitigating sustainability risks and meeting societal expectations by going beyond their mandate. However, this role will need to continue to adapt quickly to increasing demands from both legislators and investors as new ESG investing rules are set and demand surges in the future”, concludes Marc Daelman.

You will find the complete report here.