Starting in optimism after the long pandemic, just a month passed in 2022 when the world suddenly tilted into a geopolitical crisis; the Russia-Ukraine War. The war created one of the greatest humanitarian crises since World War II, its ramifications have no sign of an end.

The war sent commodity prices, including oil and energy prices rocketing. This created interwoven global crises: rising energy prices, accelerating inflation and slower global economic growth.

For environmental, social, and governance (ESG) investing, 2022 put a brake on the upward trend. On the global debt markets, ESG-related bonds contracted in 2022 after reaching almost US$1 trillion in 2021. Specifically, in the third quarter ESG-linked bonds showed a decline of 35 percent compared with the second quarter, and 45 percent compared with the third quarter of 2021, as shown in Climate Bonds Initiative 2022.

Equity investors also experienced the same thing. Yet it was much harder for ESG equity investors. As of November 2022, the MSCI World Index was down 14 percent. Meanwhile the MSCI World ESG index fell even further by 15.5 percent year-to-date (ytd). Indeed the 10 largest ESG funds posted double-digit loses, according to Bloomberg. It appears that ESG investing could not keep its promise of minimizing risks tied to environmental, social and governance, let alone getting higher returns.

 

The good things of 2022 for 2023

To reflect a little bit, there have been good things that could set a solid foundation for 2023. First are the regulatory movements globally. As is cited by some critics, the operational terms of ESG are so broadly defined that this becomes meaningless.

There is grain of truth in that. The broad definitions of ESG have blurred the boundaries of ESG investment. This has attracted some companies to claim sustainable business operations without basis. These potentially mislead investors and become greenwashing practices.

However, such practices have pushed regulators and authorities to act aggressively in making sure that certain activities are ESG-compliant. For example, the United States Securities and Exchange Commission (SEC) proposed a policy to force public companies to disclose their direct carbon emissions and have them verified by a third party. While regulations will become more stringent, this is expected to create clearer boundaries.

At the same time, global standards start realizing the importance of aligned standards. The International Sustainability Standard Board (ISSB) has proposed standards that were built upon the standards of the Sustainability Accounting Standards Board (SASB). The SASB was established more than a decade ago. Meanwhile the ISSB itself was just established during COP 26.

In 2023, we may anticipate more regulations. Yet, it appears that investors and advisory firms are expected to continue to ask companies to voluntarily disclose information relating to ESG themes. This movement will be global.

In the policy sphere, 2022 also marked optimism about sustainability investment.  In August 2022, the US Congress managed to pass the Inflation Reduction Act (IRA). This act mandates $374 billion in climate spending and is expected to speed up the energy transition and build on green technologies.

In the global sphere, countries joining COP 27 finally agreed on a dedicated fund, the loss and damage fund, and it should be settled before COP 28. COP 27 also called for more active measures by multilateral development banks such as the World Bank and Asia Development Bank.

In Indonesia, the government just secured commitments in the form of a financial deal worth $20 billion under the Just Energy Transition Partnership (JETP). Besides the fact that the commitment is high in value, the feature of the JETP showed that public-private funding in addressing climate issues is a viable mechanism.

 

Some backlashes remain in 2023

Perhaps it is only in the US in which ESG investing is framed in the political context. In recent months, ESG investing was viewed by conservative politicians as an effort by some political groups to bring about a certain political agenda. It is no surprise that ESG has been attacked from many angles.

The politicizing of ESG investment in the US will continue in 2023. Texas state lawmakers crafted legislation to restrict the use of ESG criteria. Some states in the US, such as Florida, plan to pull their funds from Blackrock, the world’s largest asset manager and a strong supporter of ESG, Bloomberg reported. Such actions may spill into emerging markets as well.

Meanwhile European countries face different challenges. Despite no legal challenge limiting ESG investing, the energy crisis will linger into 2023. With the prolonged conflict, European countries will continue to experience an energy crisis. This will place energy security and affordability above sustainability.

The global economic slowdown clearly adversely affects ESG investing. Just a few days ago, Kristalina Georgieva, the managing director of the International Monetary Fund warned that a third of the global economy will be hit by recession this year.

Meanwhile the US, Georgieva said, may escape from the worst of the downturn. Some forecast that the US Federal Reserve will raise the Fed Fund Rate and some forecast that the rate might end 2023 at 5 percent, according to Martin Wolf. Higher interest rates globally and recession will potentially reduce the risk appetite of investors for ESG investing.

 

Prevailing over turbulence

It is almost with certainty that we face a turbulent period. But there are reasons for being optimistic on ESG investing in 2023. A recent paper by Baker, Egan and Sarker suggests that investors are willing to pay higher fees for a fund with an ESG mandate. That is, investors are accepting lower financial returns for accruing both the psychological and societal benefits of ESG.

In Indonesia, the recently passed law on financial sector development and strengthening will address issues surrounding the deepening of Indonesia’s financial markets, including strengthening the green economy. The law also mandates the expanded role of the Financial Services Authority in supervising carbon trading. This means that such an institution will be in place.

Renewable energy projects remain an attractive sector. The Bloomberg New Energy Forum has suggested that the energy transition will open investment opportunities worth $2 trillion to $3.5 trillion over the next three decades.

Sustainable transportation will be the next trend. There is a growing demand for affordable electric vehicles (EVs). Automakers including Toyota, Hyundai and Wuling have committed to invest in EV manufacturing facilities. On battery manufacturing, Indonesia has received investment commitments of almost $15 billion from LG Energy Solution and CATL. Together with the JETP commitments, 2023 gives some hope that ESG investing and sustainable projects will roll in.

Finally, ESG will continue to be a significant landscape feature in 2023. Thus, Indonesian businesses and government need to prepare to navigate the rapidly changing global investment environment and also ESG standards.

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The writer is head of Mandiri Institute