Introduction
Over the last two decades, Environmental, Social, and Governance (ESG) investing has shaped how capital is allocated toward responsible business practices. ESG ratings helped investors assess how companies manage sustainability-related risks and incorporate these considerations into portfolio decisions.Yet, a shift is underway. A growing number of investors are recognizing that ESG risk management, while necessary, is not sufficient. Today’s imperative goes beyond avoiding harm: it requires actively enabling positive change. ESG ratings can signal how well a company is managing sustainability risks but it is also important to show how the company is impacting people and the planet.
This marks a critical evolution. As climate change, regulatory developments, and environmental degradation increasingly influence market dynamics, financial institutions are reassessing how sustainability factors inform investment decisions. Investors are beginning to view their role not only in terms of risk-adjusted returns but also in terms of how capital allocation contributes to broader economic and environmental outcomes.
The Limitations of ESG Risk Frameworks
Traditional ESG frameworks focus on how sustainability issues may affect a company’s financial performance, not how a company affects the world around it. This inside-out perspective protects portfolios from risk, but does little to challenge harmful business models or incentivize systemic change.
Key weaknesses include:
- Weak Link to Outcomes: Companies can score well on ESG ratings while continuing to pollute, exploit labor, or lobby against climate regulation—so long as they manage the reputational risk. This loophole fuels greenwashing and misleads investors.
- Reputational and Regulatory Risk: Investors relying solely on ESG ratings risk overlooking material real-world issues. A prominent example is Volkswagen’s 2015 emissions scandal. Despite receiving strong ESG scores prior to the incident, the company was found to have installed defeat devices in millions of vehicles to manipulate emissions tests. The fallout included over $30 billion in fines, recalls, and legal costs, along with a sharp downgrade in ESG ratings—underscoring the limitations of risk-based ESG frameworks in detecting hidden, systemic misconduct.
Read more: ESG Risk Ratings vs ESG Impact Ratings
The Rise of Impact Investing
To address these shortcomings, investors are moving toward a focus on real-economy impact: generating measurable, positive outcomes in environmental and social domains alongside financial returns.
What is Real-Economy Impact?
It is the tangible difference a company makes in the world, lower carbon emissions, improved access to healthcare, safer working conditions, not just improved ESG scores or clean branding.
What’s driving the shift?
- Regulatory Evolution: Frameworks like the EU’s Sustainable Finance Disclosure Regulation (SFDR), EU Taxonomy, and standards from the International Sustainability Standards Board (ISSB) are setting a new bar. These rules compel investors to disclose not only risks, but actual sustainability outcomes. The SFDR’s requirement to report on Principal Adverse Impacts (PAIs) is a direct proxy for measuring real-world effects.
- Stakeholder Pressure: Investors are demanding accountability. According to Morgan Stanley, 95% of millennials express interest in sustainable investing, expecting companies to contribute to societal progress, not just mitigate risk.
- Systemic Change Awareness: Issues like climate breakdown, biodiversity loss, and social inequity are now seen as systemic threats to global markets. Passive risk avoidance is no longer enough; proactive capital reallocation is needed. Transition finance exemplifies this, funding the decarbonization of hard-to-abate sectors like steel and cement, rather than excluding them.
How Financial Institutions Are Responding
Leading financial institutions are embedding the principle of “double materiality” recognizing that sustainability is both a financial and societal issue, into strategy, governance, and operations.
Key trends include:
- Impact-Focused Portfolios: Investors are designing thematic strategies focused on climate, social equity, and inclusive growth. For instance, BlackRock’s Impact Opportunities Fund and Triodos IM’s mission-driven portfolios are examples of funds moving beyond ESG screening to actively target outcomes.
- Collaborative Models: Public-private partnerships with development finance institutions (DFIs) are expanding, enabling capital deployment in underserved regions or sectors with strong impact potential.
Rethinking Fiduciary Duty and Risk Management
Perhaps the most profound implication of this shift is the redefinition of fiduciary duty. The traditional notion maximizing short-term returns is increasingly viewed as outdated in the face of long-term planetary and societal risks.
- Intergenerational Equity: Ignoring sustainability risks today threatens wealth and stability tomorrow. Investors are beginning to factor in the interests of future generations as part of fiduciary responsibility.
- Alignment with Global Goals: More than 450 institutions managing over $130 trillion under the Glasgow Financial Alliance for Net Zero (GFANZ) have pledged to align portfolios with science-based climate goals, embedding long-term planetary health into investment mandates.
- Forward-Looking Risk Assessment: Tools like the Network for Greening the Financial System (NGFS) climate scenarios and the Taskforce on Nature-related Financial Disclosures (TNFD) are enabling more granular, forward-looking risk assessments rooted in real-economy outcomes.
Data, Technology, and the Push for Standardization
Measuring impact is inherently complex due to its qualitative, contextual, and often non-linear nature. Attributing outcomes directly to investor actions can be challenging, and the variety of reporting frameworks adds further complexity to making consistent comparisons.
Inrate’s Impact Ratings address these challenges by going beyond traditional ESG assessments. They combine a unique business activity evaluation with an in-depth analysis of company disclosures. What truly sets Inrate apart is its strong emphasis on real-world impacts through analyzing the business activities of companies and combining it with a company disclosure and controversy analysis. This comprehensive approach offers financial institutions a nuanced, forward-looking perspective on how companies contribute to sustainable development, empowering investors to make better-informed decisions that align both with risk management and impact objectives.
Strategic Considerations for Financial Institutions
Moving from ESG compliance to real-economy impact requires strategic alignment and structural change.
- Revised Investment Mandates: Portfolios are being reshaped to integrate sustainability outcomes, not just risk screens.
- Governance Reforms: Institutions like AXA IM and Nuveen have formalized impact governance at the board level, embedding accountability into decision-making.
- Upskilling Teams: Investment professionals are increasingly trained in sustainability science, systems thinking, and impact assessment to interpret complex data and make informed decisions.
- Avoiding Inaction Risk: The cost of delay is mounting. CDP estimates $4 trillion in corporate assets are at risk by 2030 from climate-related impacts if transition plans are not implemented. Beyond losses, reputational damage and declining investor confidence are real threats.
Conclusion
The move from ESG risk management to real-economy impact is not just a trend, it is a necessary evolution. Investors must go beyond asking, “Is this company managing its risks?” to “Is this company improving or degrading the world around it?”
In an era defined by climate urgency, social inequality, and ecological fragility, financial institutions have both the responsibility and the tools to lead. Impact investing is not a niche, it’s the future of finance.
Let this be the decade when the financial system evolves from ESG awareness to true impact accountability.
