The U.S. lags other wealthy countries in prioritizing sustainable investing, participants in virtual panel hosted by the Institute for Energy Economics and Financial Analysis (IEEFA) said last week.

Despite progress in recent years, the panelists said, the mainstreaming of sustainable investing still faces structural hurdles, particularly at the institutional level, with financial service providers and regulators only slowly responding to the impact of climate change.

Tanya Kar, finance campaigner for the Sunrise Project, laid much of the blame on the country’s top investment houses.

“I think it’s clear that the leading asset managers fundamentally misunderstand climate risk,” she said.

The “big three” investment firms — BlackRock, Vanguard and Fidelity — manage more than $26 trillion in combined assets, more than the U.S. GDP of about $21 trillion.

“Yet these asset managers have failed to act in a way that protects the global economy from what is arguably the biggest threat of systemic risk, which is climate change,” Kar said.

Kar called out BlackRock and Vanguard as the most “egregious laggards” among asset managers in climate-conscious investing, pointing to their “enormous exposure to the full breadth of the economy.”

“Vanguard alone has stakes in more than 10,000 companies. This entails a significant amount of influence through shareholder power, which these firms could easily leverage to push their portfolio companies toward more robust climate action — but they don’t,” Kar said.

Kar said that in response to growing criticism about their shareholder voting, both firms have begun making limited disclosures of their votes on climate-related issues, but “usually well after the decisions have been made.” She contended that in the “climate-critical” sectors where they have investments, such as energy, utilities, industrial and automotive, BlackRock and Vanguard “shield” company managers from accountability over climate issues and nearly always vote for company-proposed directors.

“BlackRock and Vanguard also tend to vote overwhelmingly against climate shareholder resolutions, even ones that are flagged by Climate Action 100+, which BlackRock joined last year in the wake of [CEO] Larry Fink’s promise to center climate in a renewed emphasis on sustainable investing,” Kar said.

Kar accused the two companies of “greenwashing” their reputations, noting that while both have recently signed on to the Net Zero Asset Managers Initiative, Vanguard has recently surpassed BlackRock as the largest coal sector investor among managers.

“Despite public commitments to align portfolios with the goals of the Paris Agreement, the biggest fund managers have actually increased investments in thermal coal — which is the dirtiest of the deadliest fossil fuels — since 2016, when the Paris accord was signed,” Kar said.

Sustainable Still the Alternative

Diederik Timmer, executive vice president at Sustainalytics and chair of US SIF, a U.S.-based association working to improve the country’s sustainable investing environment, agreed that “the U.S. is really significantly behind what … is happening in Europe, in Australia or in Japan.”

But he added that the “investment space” is not a “homogenous field,” noting the roles of asset owners, such as pension and venture funds and insurance firms; retail investors and their advisors; and asset managers that create investment products.

“We think they operate in very different ways and have different objectives, so I think it’s hard for me to just use one paintbrush to color it all,” Timmer said.

After moving from Europe to the U.S. nearly a decade ago, Timmer visited the boards of large state pension funds and found only a few — including California’s CalPERS and Florida — were “super active” in sustainable investing. At the time, Timmer had to explain the concepts of environmental, social and governance (ESG) investing to many fund managers, he said.

“I think we’re really beyond that point, especially in the institutional asset owner space,” he said. “I don’t think that there’s many professionals that haven’t heard about sustainability, or ESG, and how it relates to their investment decision-making. It doesn’t mean that they’re all doing things, but it certainly hit their radar, and they have that first level of awareness.”

For many investment firms, sustainable investing has been relegated to the alternative portion of their portfolio, rather than being included in their normal fixed income allocations, Timmer said.

Timmer said the U.S. is unique in that sustainable investing is being driven by retail and private wealth investors who want their portfolios to reflect their concerns about the climate, rather than institutions.

“What you’re describing is really fascinating to me, because I’m familiar with this institutionally driven process out of Europe and in other markets,” responded panel moderator Melissa Brown, IEEFA director of energy finance studies for Asia. In the U.S., she said, “we’ve got this bottom-up process that’s at play.”

Hurtling Toward the ‘Climate Cliff’

Kar said the market’s adaptation to “environmental realities” is being hampered by the predominance of index — or passive — funds, which were first created by Vanguard to passively track the S&P 500. The funds offered diversification, lower risk, low fees and strong long-term returns compared with active investment, which requires investors to select and track individual stocks.

As a result, passive index investing has surpassed active investing in the U.S. and is surging worldwide as well, Kar said.

“Index investing has not only set the economy on autopilot toward a climate cliff. It’s also turned the asset management industry into an oligopoly that is quickly becoming a duopoly dominated by BlackRock and Vanguard,” she said.

Vanguard, BlackRock Respond

Reached for comment after the panel, Vanguard spokesperson Alyssa Thornton said, “We represent our investors, who have chosen to predominantly invest in broad-based index funds.

“Index funds have revolutionized investing, and our funds are designed to provide low-cost, broadly diversified exposure to a market or market segment and closely track the risk and return characteristics of a clearly defined, target benchmark,” Thornton said. “In accordance with this mandate, our index funds do not divest from specific securities in their benchmarks, including those in fossil fuel-intensive industries.”

Thornton said that because climate risk can undermine long-term investor returns and Vanguard’s index funds are “essentially permanent owners of the companies in which they invest,” Vanguard believes its “investment stewardship” activities “are the principal levers Vanguard can use to help oversee, engage upon and safeguard fund investors from climate change risk.”

Through the program, Thornton said, Vanguard engages with the boards of carbon-intensive companies on climate risk. She said Vanguard has published “clear expectations” that boards oversee their companies’ climate-related risks and disclose climate strategies and progress in hitting mitigation targets “using widely recognized investor-oriented reporting frameworks.”

“Vanguard’s attention to climate risk and engagement with issuers will continue and, importantly, complement our work with the Net Zero Asset Managers initiative. Where our research and engagement identify companies that are not moving in line with market regulation or taking the necessary action to mitigate climate risk, we will take action on behalf of Vanguard funds,” Thornton said.

“Our conviction is that climate risk is investment risk,” BlackRock said. “Among the many initiatives to help our clients navigate this risk, we have both achieved 100% ESG integration in our active strategies and, where we have discretion in these strategies, completed the exclusion of equity and bond holdings in companies generating more than 25% of revenues from thermal coal production.”

BlackRock said it provides customers investment choice in its strategies “through the industry’s largest ESG index offering.”

“We ask all companies to disclose their plan for alignment with a global net zero economy by 2050. Companies should set short, medium and long-term targets, and carbon-intensive companies should disclose scope 3 emissions. Where we do not see sufficient progress, we take voting action,” BlackRock said.

Conflict of Interest?

Kar said asset managers are reluctant to “engage or vote” in ways that compromise their financial viability, “lose access to sources of corporate power” or lose clients, including among fossil fuel companies “that bring in millions of revenues every year.”

“Investors who own such a representative swath of the whole market should be aligning incentives and interests with the whole market, not just the potential profits and losses of individual companies,” she said. “The market has actually evolved in a way to create all the wrong incentives for climate. Asset managers should not be focused on low fees or low-cost products.”

Kar called for government intervention “to realign incentives away from following a free-market ideology, which will ultimately destroy the planet.”

US SIF has been “deeply involved” in U.S. policy for many years, Timmer said, but ESG and sustainability “weren’t particularly popular topics” with the Trump administration. And while he sees a shift in momentum under President Biden, he thinks there’s a “lack of knowledge and understanding” of what is necessary to adapt the financial markets for climate action. US SIF has recommended that the White House create an advisory committee focused on sustainable finance and business, which would work across departments to implement climate-friendly policies.

Timmer also believes the Securities and Exchange Commission has “a lot of catching up to do.”

“I really hope that they will hire more people that have knowledge on this front, and then they just need to develop policies that support environmental change,” he said.

Timmer wants the SEC to start validating the claims that asset managers make with respect to their sustainability products.

“Basically, a lot of asset managers and products are being created that state that they really have significant positive impact on the environment, and I think it would be really good to make sure that the SEC validates that these claims that are being made are actually there so that we get away from the greenwashing that’s going on,” he said.

Timmer also expressed optimism over a bill Democrats introduced into the House and Senate last month to amend the Employment Retirement Income Security Act (ERISA) guidelines to clarify that retirement plan administrators can consider ESG factors when making investment decisions and that ESG can function as a “tie-breaker” when competing investments can serve a plan equally as well. The Financial Factors in Selecting Retirement Plan Investment Act would also allow ESG assets to be allowed as default investment alternatives in ERISA-covered plans.

“This risk guideline was actually a significant hindrance for many trustees of pensions to, for instance, accept ESG or climate criteria as an important metric for investing,” Timmer said.