For the first time, U.S.-based institutional investors and money management firms with sustainability strategies cited climate change and carbon reductions as their top priority in 2022, according to a key report released by US SIF, an industry association representing the sector.

ESG-focused money managers said they applied climate change policies across $3.4 trillion in assets and fossil fuel divestment across $1.2 trillion in assets, according to the association's biennial report published Dec. 13. Avoiding investments in weapons or tobacco industries were also top concerns.

At the same time, these money managers are being more careful about how they market their funds, causing the overall market to contract.

The report identified $8.4 trillion in U.S. investment assets at the beginning of 2022 held by firms that factor environmental, social and governance into their decisions. That was a steep drop from the last assessment in 2020, which recorded $17.1 trillion in ESG assets under management.

In addition to reflecting the overall weakening of the financial market, the decline in ESG funds was likely caused by regulatory pressures, according to US SIF. Over the past two years, the U.S. Securities and Exchange Commission has been cracking down on misleading ESG claims that prompted many firms to withdraw their sustainability funds, the report said.

"For quite a long time, ESG investing — whatever that means — was the hottest new thing for everyone on Wall Street," Heidi Welsh, executive director of the Sustainable Investments Institute, or Si2, said in an interview. "But many claims of ESG were simply not accurate. So I think it's correct for the SEC to have truth in labeling."

Welsh, whose group contributed to the US SIF report, said the European Union has already tightened ESG requirements and that very few funds meet the EU standards today.

SEC seeks transparency, accurate labeling

In May, the SEC proposed changes to its "Names Rule" that would expand to ESG a requirement that 80% of assets must be invested in assets suggested by the fund name. The purpose of the change, which had been in the works since 2020, was to root out fund names that mislead investors.

The same month, the agency proposed another rule seeking to promote consistent and comparable ESG disclosures, also to bring more clarity and transparency for investors.

"Trends researchers immediately began to see multiple asset managers reporting a modest to steep decline in ESG [assets under management] as compared to their responses in 2020," the US SIF report said. The association "believes that these SEC proposals are motivating asset managers to be more circumspect in what they consider to be assets that incorporate ESG criteria."

The report identified 497 institutional investors, 349 money managers and 1,359 community investment institutions that use ESG criteria in their portfolio selection. Together, their assets under management represent 13% of the total U.S. market, the US SIF report said.

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