Introduction

ESG, responsible investing, and sustainable investing refer to incorporating environmental, social, and governance (ESG) considerations into investment decisions. In 2018, more than US$30 trillion of assets were managed under responsible investment criteria, with Europe leading adoption. In the United States, ESG assets grew to US$12 trillion, and by 2019 the Principles for Responsible Investment (PRI) had over 2,500 signatories with US$85 trillion in assets under management (AUM). Implementation, however, is inconsistent, with concerns of “greenwashing.” Drivers include societal changes, wealth transfer to younger generations, and regulation following the global financial crisis. A key question remains whether ESG enables both financial returns and positive societal outcomes.

What forces are driving ESG investing?

There is no consensus on the materiality of ESG issues, but climate change receives the greatest attention, particularly carbon risk and stranded assets. Regulatory agendas are more advanced in Europe than in the United States. High-profile ESG incidents, such as Enron, Deepwater Horizon, Volkswagen emissions, and Facebook data privacy breaches, show the risks. Private capital is increasingly leveraged to address ESG issues, with investors such as BlackRock, Japan’s GPIF, and Norway’s NBIM making ESG commitments. Companies also publish sustainability reports and adopt stakeholder value approaches, though questions remain about their sincerity.

Defining ESG

The environmental dimension relates to emissions, natural resource use, pollution, and eco-design. The social dimension covers workforce relations, customer responsibility, and community impacts. Governance includes shareholder rights, board composition, executive pay, and ethical practices.

A special focus on climate finance

Climate change is associated with physical risks such as extreme weather and transition risks requiring net-zero emissions by 2050. Studies show carbon emissions are increasingly priced into markets, with a “carbon premium” observed. Surveys of large investors reveal climate risk disclosure is seen as important but inadequate, with reputational concerns a major driver. European investors push for better disclosures and standards.

The regulatory environment

ESG reporting in the United States remains voluntary and inconsistent. In contrast, the European Union introduced a sustainable finance action plan, taxonomy, and disclosure obligations. The UK stewardship code requires investor monitoring and voting disclosure. Elsewhere, China has issued green finance guidelines, while Japan promotes voluntary disclosure. Divergence in regulatory ambition, especially between the EU and the United States, is likely to shape global investment practices.

What role can institutional investors play in corporate governance?

Institutional investors hold more than 40% of global equity, with higher shares in the United States (72%) and United Kingdom (63%). Evidence suggests good governance is linked to firm value, though results vary by context and time. Activism has become more effective in recent decades, particularly hedge fund activism. Foreign institutional investors have influenced governance convergence globally, improving monitoring and performance. The “Big Three”—BlackRock, Vanguard, and State Street—control 25% of US equities, raising debate over whether they do too little in stewardship or potentially too much by encouraging anti-competitive outcomes.

What role can institutional investors play in E&S/CSR issues?

Theoretical debate continues on whether firms should maximise shareholder value alone or account for stakeholder welfare. Empirical evidence is mixed. Meta-analyses suggest a generally non-negative relationship between ESG and performance, though causality is uncertain. Studies find “sin stocks” outperform due to investor exclusion, while companies with strong employee satisfaction or high CSR during crises show stronger returns. Evidence on ESG funds shows no consistent outperformance compared with conventional funds.

New evidence on ESG incorporation from the PRI

By 2019, PRI signatories represented more than US$80 trillion in AUM. European investors lead by numbers, while North America controls more assets. Strategies include engagement, integration, and screening, with thematic approaches still niche. Studies of PRI signatories show better portfolio ESG footprints, though weaker for US signatories. Engagement through the PRI Collaboration Platform has delivered improved corporate financial and ESG outcomes, especially when supported by lead investors.

Many open questions

Challenges include ESG data quality, rating divergence, and potential biases by firm size, geography, and industry. Concerns also exist over reliance on proxy advisory firms. ESG integration in asset classes beyond equities, such as bonds, is underresearched, though green bonds and sustainable real estate are growing. Investor demand is driving flows, with many beneficiaries willing to accept lower returns for sustainable investments. Measuring real-world outcomes and aligning with the UN Sustainable Development Goals remains limited.

Conclusion

Institutional investors have shaped governance practices and increasingly influence environmental and social outcomes. Europe leads in regulatory ambition, particularly on climate change. ESG investing has grown significantly but faces ongoing challenges around measurement, effectiveness, and impact. Research remains sceptical yet evolving, with calls for greater academic and practitioner collaboration to address pressing societal issues.