By Eric Pedersen, Head of Responsible Investments at Nordea Asset Management

With only a few months to go until the implementation of the MiFID sustainability update in August 2022, investors have been abruptly and brutally reminded that geopolitical and governance risks are real and must be taken into account. At the same time, questions about uneven implementation of the EU’s Sustainable Finance Disclosure Regulation and the upcoming MiFID sustainability update have already been raised. As always, NAM will stay true to our long history as an ESG investors and will serve clients across Europe and Globally with solutions that are fit for purpose.

The investment industry’s attitude towards ESG has been permanently transformed. After years of being considered niche, sustainability has become a mainstream consideration for most investors. However, while investors are now acutely aware of the numerous benefits of ESG, philosophies and approaches still vary widely. Nowhere is this more evident than in the debate between engagement and exclusion.

At Nordea, we are not afraid to exclude companies when we find it necessary, for example because of breaches of international norms, or of the specific ESG standards of individual portfolios. At the same time, we believe engagement can be a powerful tool to foster positive change, while protecting shareholder value and enhancing long-term returns.

The engagement or exclusion question intensified recently during the COP26 climate summit, with many participants calling for investors to essentially shun all high carbon emitters – particularly companies operating within the mining sector. In addition to climate considerations, investors understand the mining industry has exposure to many other significant sustainability risks – including those related to worker safety, biodiversity protection, and the protection of human rights and livelihoods.

Within the world of ESG investing, 2022 is set to be a year of change. Gliding on a path of success and following several years of explosive growth, the industry has been working at full throttle to implement the concepts that will be key to the new MiFID regime.

Beginning in August, European retail investors can expect their financial adviser to ask them questions about their sustainability preferences. These questions, according to the European regulator, should be centred around three issues: The Principal Adverse Impacts (PAI) of their investments on environmental and social issues, and the proportion of “Sustainable Investments”, and of EU Taxonomy-aligned investments, in a given investment product. How this will be implemented in practice in each country remains unsettled, as distributors are still determining their approaches, and national regulators are in some cases adding so-called “gold-plating” (i.e. added requirements) to the EU regulation.

At the same time, the demands on institutional investors regarding ESG continue to increase in both number and complexity. In the near term, this is especially topical in the area of portfolio decarbonisation and net-zero commitments, but social issues and biodiversity are important themes on the horizon, which will require attention.

At the time of writing, the invasion of Ukraine by Russian forces, and the knock-on effects of sanctions on energy markets are raising questions about the nature of ESG and the ability of ESG strategies to outperform in different market scenarios. At NAM, we believe this is the time to reiterate that ESG, broadly defined, is not in itself a guarantee of higher – nor of lower – returns over a given period. In situations characterized by tightness in the market for fossil fuels, strategies that do not own oil and gas assets will be challenged to keep pace. When defence budgets surge, strategies that avoid defence stocks must find other avenues for investment. On the other hand, investors that for ESG reasons had low or no exposure to Russia have reaped financial as well as moral benefits.

However, while not all ESG risk is financially material in the short term, the trend is for regulation and policy goals to change this: Only recently, the EU introduced regulation on supply chain due diligence, which will make the environment for companies ignoring biodiversity and human rights risk increasingly difficult. In the same way, the fact that higher carbon prices and direct regulation of emissions are coming is beyond debate. And finally, higher fossil fuel prices in themselves will, together with the underlying geopolitical considerations, support the decisions now taken by national governments to dramatically increase the pace of renewables coming online.

All in all, we remain convinced that prudent management of financially material sustainability risk improves the risk/return relationship in the long term – and we know from experience that our disciplined analysis and security selection has the ability to deliver strong performance, even in challenging times. We also know that in some cases, even things that one cannot put a price tag on are important – and that this is exactly what the SFDR concept of “double materiality” asks us to address.

It is on this basis that we will continue to give our investors and distributors a full range of choices in ESG investing, providing the data and disclosure needed to fulfil the requirements of SFDR and MiFID, and addressing the need to decarbonize investment portfolios in a way that creates real-world impact – all while striving to deliver superior investment performance. That is what being an ESG leader means to us at NAM.