Public Policy Drives Sustainable-Investing Markets in 2025

As originally published on Morningstar.com.

The approach to Earth Day 2025 has seemed gloomy at times, as the US commitment to climate action and sustainability wavers under the new administration. At the same time, lurching markets are vexing investors and companies. But new opportunities are always emerging, including one for Europe to take the lead with policies that could attract more investments for green technology.

So says Hortense Bioy, head of sustainable-investing research for Morningstar Sustainalytics. “In Europe, we’re very aware that if we don’t increase investment in this space, China will take the lead because they are not stopping there,” Hortense told me.

I spoke with Hortense in the days leading up to Earth Day to get her read on the landscape for sustainable investing, including the regulatory outlook and the latest data for investment flows. Keep reading for more of our conversation.

Ron Bundy: It’s been an active year so far for investors, with a broad list of challenges ranging from social issues to regulatory to geopolitical issues. Then the tariffs from the Donald Trump administration created challenges. What are you seeing so far in terms of investment flows?

Hortense Bioy: It’s been a challenging start to the year for all investors, but even more so for sustainability-oriented investors, against a backdrop of rapidly evolving policy and economic environment. We’re seeing continuous outflows from sustainable funds in the US. In Europe, after years of inflows, flows may turn net negative in the first quarter. Several factors have weighed on investor appetite for sustainable strategies in the recent past, including performance, which has been disappointing, especially in key sectors such as renewable energy and climate solutions. A hot topic of discussion right now is whether sustainability-oriented investors should invest in the defense sector as Europe rearms. Sustainable strategies have historically stayed away from defense companies mostly for ethical and reputational risk reasons, but this is changing. Let’s see if that has an impact on flows.

DEI and Investing Outlook

Bundy: Let’s cover other big themes for sustainable investors. You recently wrote about reversals in diversity, equity, and inclusion initiatives, including President Trump’s executive order that asks federal agencies to scrutinize DEI programs. What are the impacts of this order?

Bioy: Many high-profile US companies, including Meta META, McDonald’s MCD, and Bank of America BAC, have rolled back DEI initiatives following the executive order that exposes companies to legal action. Some investors are concerned because many employers believe diversity is good for business. Out of the 20,000-plus companies that Sustainalytics researches, more than 80% have a diversity program, which often includes DEI training and hiring practices. If these programs are scaled back or in some cases completely disappear, what impact will that have on companies’ long-term performance? That’s what investors are keen to find out.

Some companies say that, while some policies have disappeared, in effect, nothing will change. For others, changes will be more consequential. Sustainalytics evaluates DEI programs as part of our human capital assessment of companies. Human capital matters more in knowledge-intensive sectors such as technology.

One challenge for investors will be monitoring real changes if companies report less on DEI. We know also through our engagement services that some companies today simply just don’t want to engage with investors on this topic because of the political climate. They’re worried about legal implications as well. So, on this issue, it’s a difficult time for both companies and investors.

Tariffs and Sustainable Investing

Bundy: What impact will the new administration’s tariffs have on the sustainable-investment markets now and later this year?

Bioy: US public policy has so far this year been the biggest driver of share price performance and that is likely to continue. The challenge for investors is navigating the uncertainty, and the recent tariff saga is just a new reality that will evolve. Investors are still waiting to see which countries and sectors will be affected and how.

There is also a lot of uncertainty around the Inflation Reduction Act. The IRA is unlikely to be fully repealed because Republican states have been the biggest beneficiaries of the tax credits and other incentives the IRA offers. But we still don’t know what will be left of the IRA and, as a result, how much investment will stay in green sectors.

Bundy: What are some of the global implications of these decisions?

Bioy: It could be an opportunity for other countries to take the lead or, in some cases, strengthen their position. I’m thinking of Europe, which is still striving to become the world’s first carbon-neutral continent by 2050. Europe is currently looking for ways to enhance its competitiveness and reduce its energy dependence, while maintaining the momentum of the green transition. Europe is planning to make itself more attractive for investments in technology and green solutions. Germany’s likely new chancellor, Friedrich Merz, has also announced plans to increase spending in the low-carbon transition. At the same time, it’s critical for Europe to reduce its dependence on China, which controls the entire green energy supply chain.

ESG and Regulation

Bundy: Let’s talk about the important regulatory changes in the global market, starting with the European Union Omnibus packages around disclosure.

Bioy: We predicted that 2025 would be a pivotal year for regulation, and that’s the way Q1 started. Europe is reviewing three key measures: the Corporate Sustainability Reporting Directive, the Corporate Sustainability Due Diligence Directive, and the EU Taxonomy. With the Omnibus package, all three measures are expected to be simplified and their scope reduced. Some companies welcome the move because it lightens their reporting burden. But for investors, it will mean less data and comparability, as 80% of companies will no longer be required to disclose taxonomy alignment and/or do some CSRD reporting. It means investors will have to rely on third-party data providers. The good news is that the concept of double materiality, which requires the disclosure of both sustainability risks and impacts, remains, and the EU will stay the course on its green agenda.

Also, we expect many companies that fall out of the scope of the regulations to make voluntary disclosures because they think it’s good business practice. They’ll see it as an opportunity to align with the global climate agenda and build stakeholder trust. We also expect investors to continue their engagement with companies and ask them to enhance their disclosure because investors have a fiduciary duty to consider sustainability factors. According to a Sustainalytics survey conducted last year, two thirds of asset owners consider sustainability factors to be more material than before.

Bundy: How about outside Europe?

Bioy: Outside Europe, the standards developed by the International Sustainability Standards Board are gaining traction. Some 30 jurisdictions representing more than half of global GDP are making progress toward adopting the ISSB standards in their legal and regulatory frameworks. Several countries are also introducing taxonomies, especially in emerging markets.

In the US, the Securities and Exchange Commission has indicated it will reverse rules requiring public companies to disclose greenhouse gas emissions and climate-related risks. But at the state level, there are still initiatives like California, which will still require companies headquartered in the state to disclose climate risk.

Climate-Investing Trends

Bundy: Since Earth Day is approaching, what trends are you seeing in climate investing?

Bioy: A majority of asset owners consider the transition to net zero emissions to be the most material environmental factor for decision-making. And that is not surprising given that many have made net zero commitments. As universal owners, they believe it’s in their best interest to address systemic issues like climate change as it will impact their long-term investments. But how can they meet that commitment in a world that’s not aligned to net zero? We’re seeing a growing desire among investors to enable the transition by financing and investing in companies that are transitioning rather than simply excluding high emitters. These companies can be in the mining, traditional energy, or transportation sectors. More investors also look to engage with high-emitting companies to encourage them to set emission reduction targets and develop transition plans.

As a result, we’re seeing a growing and increasingly diverse range of investment products that target the transition. Some of these products invest in companies focused on building low-carbon energy capacity. Others focus on companies that enable the transition, in the materials, industrials, and technology sectors, for example. Others invest in transition leaders—that is, companies with decarbonization targets and credible transition plans. Others invest in green bonds. There’s a wide range of strategies. We have identified more than 1,600 mutual funds and ETFs globally that have a climate-related mandate, representing about $570 billion of assets.

Bundy: We’re in the middle of the company proxy season. What are you expecting?

Bioy: We expect the number of ESG-related resolutions and investor support for these to decline in the US, given anti-ESG political pressure. We’re already seeing signs of this happening. Follow This, a high-profile campaign group, has announced that it won’t file any resolutions this year, stating that investors had become increasingly reluctant to use their voting power. At the same time, the SEC recently issued new guidance making ESG engagement harder and potentially limiting investors’ ability to request ESG information and influence companies. In this context, investors will need to carefully consider the implications for their investments.

Bundy: Thank you, Hortense, it’s been illuminating and insightful as always.