The world of sustainable investing has shifted rapidly over the past three years. Even before Donald Trump began his second term, the euphoria that had characterized the market for investments according to environmental, social and governance criteria (Environmental, Social, Governance; ESG) for years had already faded. Since then, the headwinds have intensified; for example, the acronym DEI for Diversity, Equality and Inclusion has largely vanished from the vocabulary of many international companies.

Zürcher Kantonalbank (ZKB), the second-largest asset manager in Switzerland, manages more than CHF 350 billion in assets under the Swisscanto product brand. ZKB embraced sustainability early on; René Nicolodi, who has been working for the state-owned institution for almost a quarter of a century, has helped shape this approach, first as an analyst for Sustainable Responsible Investing, then as Head of Sustainable Investments, and today as Head of Equities and Deputy Head of ZKB Asset Management. His first professional stop, however, was UBS in 1997, where he worked in the Corporate Actions Department.

How does he assess developments in the ESG area? What is his stance on currently controversial topics? The answers can be found in the interview that finews conducted with Nicolodi in a plain meeting room in the sober Hard office building in Zurich's industrial district.

Mr. Nicolodi, three years ago banks and asset managers would volunteer information about their ESG product range in conversations; today, you have to practically pull it out of them. What happened?

I smile a little when I see this wave-like movement because I have been observing the market for quite some time. In the late 1990s and early 2000s, as a corporate governance analyst, I experienced and analyzed the Parmalat, Enron and Wordline fraud cases. The United States responded with the Sarbanes-Oxley Act. Then the climate movement reached its first peak with Al Gore's film "An Inconvenient Truth." Later came the boom in renewable energy. ESG development does indeed move in waves, but the long-term structural trends remain intact, and the importance of the topic is increasing. It is about social responsibility, the efficient use of natural resources and the role of capital markets. The latest countermovement, which began two to three years ago, has something positive about it as well: There was a lot of hot air in the sustainability space, promises that could not be kept.

What role does regulation play?

For years, it has supported and driven the development of a sustainable financial world. However, in my view, the EU in particular went too far with its laws. They led to a huge compliance exercise and raised numerous implementation questions. Now the EU is trying, with its Omnibus package, to streamline, or rather debureaucratize, sustainability reporting regulation and disclosure requirements in particular. That is also necessary so that the whole thing does not become absurd in itself. But data and reporting remain important so that market participants can form an opinion about a company. Incidentally, the uniform integration of sustainability into international accounting standards is also continuing somewhat under the radar.

As a sustainable equity analyst, don't you have two souls in your breast? On the one hand, you can see that regulation has gone too far; on the other, aren't the most detailed possible taxonomy and sophisticated standards good for comparability, for example in CO₂ calculations?

Your observation is partly correct. The more transparent and comparable data are, the better. However, it is obvious that a small-cap company cannot report in the same way as Nestlé, including on ESG. And as for the regulation of financial market participants, that is, banks and asset managers: standards are also generally welcome here, but there are hundreds of possible and perfectly legitimate definitions of sustainability. The EU should not try to define the curvature of a banana. Principles-based approaches, as they are more commonly pursued in Switzerland, make more sense in my view.

"The EU should also not try to define the curvature of a banana when it comes to sustainability."

Is it actually sensible for the state to use regulation of the financial industry to accelerate the transformation of the economy?

I am torn on this question about whether, and how far, the state should directly steer capital flows. CO₂ is emitted in the real economy, so the lever for reducing it must primarily be applied there through pricing mechanisms. It is up to the markets, within a set of guardrails, to establish a price through the interplay of supply and demand. At the same time, it is right and important that the financial industry, as an intermediary, can set significant priorities in capital allocation and lending.

Can you give an example?

The markets will provide sufficient capital for the expansion of network infrastructure when the prospects of earning an attractive return are appealing. If, for example, barriers to entry for manufacturers of large storage batteries are low, this reduces return expectations and, accordingly, the inflow of capital.

How have your clients reacted to the rather hostile environment for ESG investments?

Under the Swisscanto brand, we primarily serve institutional clients, pension funds and family offices. In recent years, all pension funds have had to engage intensively with sustainability, climate data or decarbonization pathways due to regulation in the investment area. These are relatively conservative institutions that have now established and internalized these processes. ESG standards therefore remain relevant and are, for example, a mandatory part of requests for proposal (RfPs), without which one can no longer win institutional mandates.

"Without ESG standards, you can no longer win institutional mandates today."

In practice, sustainability is strongly dominated by the climate issue. Doesn't that leave other aspects shortchanged?

On the one hand, climate change is the biggest systemic risk, and one that is closely linked to many other ESG areas. Besides the obvious questions of energy transition and energy security, climate change can, for example, lead to increased migration, which in turn raises social issues. On the other hand, the dominance also has to do with the fact that data, definitions and causality in this area are already well developed and there is a fairly broad consensus. That is not yet the case to the same extent with biodiversity or the circular economy.

Swisscanto has offered a "dark green" global equity fund with a focus on energy and climate for more than 20 years, which meets the requirements of Article 9 of the EU Regulation on the Disclosure of Sustainable Financial Products. Over the past ten years, this fund has always outperformed the benchmark, the MSCI World equity index. Are you simply riding the wave of rising oil prices?

No. The long-term trend clearly points toward electrification with a focus on efficiency. Accordingly, investments in renewable energy exceed those in oil and gas by many multiples. But fossil fuels still play an important role in the overall energy mix. Supply and demand shocks in the oil sector therefore affect the level of all energy prices. That will remain the case for some time.

How do you select the stocks in this fund?

Implementation takes place through a multi-stage filtering approach. First, we exclude certain sectors, for example companies that extract coal, oil or gas. Then we specifically look for companies that will benefit from future growth in certain areas and technologies.

"Compared with global investment in renewable energy, the amounts going into the nuclear complex are negligible."

Nuclear power is considered low in CO₂. Do you have the sector in your fund?

No, we exclude it, not because of climate considerations, but because of other risks, both in operations and in waste storage. In Switzerland, there is currently debate about allowing nuclear power again. We regularly review our exclusion criteria in light of current developments. But one must keep the scale in mind: Compared with global investment in renewable energy, the amounts going into the nuclear complex are negligible.

Another hotly debated topic in ESG circles is defense stocks, especially since Russia's attack on Ukraine. Are you invested there?

Defense stocks remain on the blacklist for our most sustainable products. It is also hardly possible to invest in Switzerland's security this way, because there are very few domestic stocks. The industry is mainly based in the United States and partly in Europe.

"It is hardly possible to invest in Switzerland's security through defense stocks."

And what about Holcim, which is responsible for a large share of Swiss CO₂ emissions?

We are invested in Holcim because that is where we can have an impact. Cement is a construction material whose production releases a lot of CO₂. But the company has projects, reduction targets, measures and a track record. As asset managers, we must not be dogmatic; we can also advance our concerns through dialogue with companies.

What happens after the exclusion criteria have been applied?

In the most sustainable funds, a positive selection then takes place. The focus is on the quality of the company and the impact of its products. We analyze companies fundamentally, meaning we include financial metrics. We look for companies with high quality and strong value creation. Through a sustainability lens, we take a thematic approach. That requires the courage to deviate significantly from the benchmark at times in order to generate alpha. Only in this way will active management in equities continue to have a right to exist.

The path away from fossil fuels and toward renewable energy is quite rocky. Wind and sun alone are not enough; resources such as rare earths and a robust grid are also needed. Dependencies are not decreasing; they are shifting from oil countries to China. How do you deal with such tensions?

Our job as asset managers is full of contradictions, and we must be able to live with permanent uncertainty. That is always the case in investment decisions. What portfolio managers want to avoid as much as possible are reputational risks that rapidly and uncontrollably turn into economic risks. ESG analysis can provide valuable additional input here.

"Our job as asset managers is full of contradictions."

Let's take a concrete hypothetical example: A Chinese manufacturer produces cheap and efficient solar panels, but is suspected of using forced labor. How do you decide?

In that case, we would not invest there because of risk considerations. But I can also give you a prominent real-world example. Tesla also has a superb product from an ESG perspective, but its governance is problematic in several respects, which in our view represents a business risk. Accordingly, we are not invested in Tesla.

Do you have direct contact with the companies in your portfolio?

As the second-largest Swiss asset manager, we meet practically all the companies in our portfolio. And our network of international brokers also secures us access to major foreign companies. In sustainable vehicles, we hold Swiss equities to the tune of around CHF 38 billion. In particular, with Swiss companies, we exchange views intensively on ESG topics with the board of directors and executive management. Internationally, we use alliances with partners to be able to exert better influence.