Outlook 2026: Sustainability's reality check

Europe’s journey with ESG (Environmental, Social, and Governance) investing has been nothing short of transformative. In the early 2020s, a wave of sustainable finance swept the continent, with investors, institutions and policymakers rallying behind ambitious net-zero targets, climate-focused funds booming and regulatory frameworks like the EU’s Sustainable Finance Disclosure Regulation (SFDR) setting the pace for global markets. But the landscape is shifting. Initial exuberance is giving way to a more pragmatic approach. Nonetheless, in the face of intensifying pressures such as climate shocks, the integration of ESG considerations into investment decision making has become all the more pressing, in order to manage risks and maintain competitiveness and future-readiness.

The pragmatic turn for ESG investing

Following the ‘golden years’ of rapid ESG adoption matched by capital flows, the European sustainable investment landscape is now experiencing a significant shift. The exuberance that defined the early 2020s, when ESG considerations, especially carbon metrics, became central to portfolio construction and market innovation, has given way to a more sober approach. Rather than focusing on broad ESG alignment, investors are now homing in on the credibility of transition pathways. The expectation is not merely to state ESG intentions but to demonstrate tangible progress, robust blended finance structures and proof of delivery over promises.

This pragmatic turn is especially pronounced as external shocks continue to challenge the regulatory and investment environment. The war in Ukraine, for instance, has fundamentally altered the EU’s energy security calculations, forcing a reallocation of public funding toward reindustrialisation and military readiness. Meanwhile, China’s assertive and somewhat opaque climate industrial policy has intensified concerns about Europe’s capacity to maintain technological sovereignty in critical green sectors such as solar PV, battery technology and green hydrogen. These developments underscore the necessity for Europe not just to lead in ESG rhetoric, but to reinforce its position with credible, innovative and resilient financial frameworks.

The European Investment Bank’s 2024 Climate Investment Report crystallises this reality check. It calls for the deployment of blended finance models, combining public and private capital, alongside first-loss guarantees and carbon contracts for difference, in order to de-risk and unlock private investment in carbon-intensive sectors. These mechanisms are seen as essential for moving beyond compliance towards the actual transformation of high-emitting industries, ensuring that capital is directed where it can drive measurable change.

This recalibration is also evident in sustainable fund flows. So far this year, sustainable equity funds have seen outflows across Europe, the US, and APAC, a stark contrast to the earlier boom, while sustainable fixed income products have attracted consistent inflows in all regions.

As the initial momentum meets the test of reality, there has not been a retreat from ESG, but rather an evolution towards greater accountability, strategic focus and resilience. The shift reflects both external pressures and the internal need for businesses and investors to integrate sustainability in a way that withstands shocks, whether geopolitical, economic, or environmental, while continuing to drive value and long-term competitiveness.

Outlook for 2026 - navigating uncertainty amid unchanged challenges

Looking ahead to 2026, the global outlook for ESG investing remains clouded by persistent geopolitical and macroeconomic headwinds. While there is cautious optimism that conditions could become more favourable, the underlying reality is that the fundamental challenges confronting businesses and investors have not shifted; if anything, they have become more pronounced. The ESG landscape is expected to continue evolving, holding firm in the face of uncertainty, preparing for a future upturn. However, it is crucial to recognise that the core issues remain as urgent as ever.

Amid widespread discussion about regulatory delays and political pushback, there is a risk that ESG could be relegated to the sidelines, mistakenly perceived as a concern that can be postponed. This is a dangerous misconception. The risks facing businesses, including supply chain disruptions and increasingly stringent investor expectations, have not disappeared. In fact, these pressures have only intensified, reinforcing the imperative to integrate sustainability at the heart of business strategy. ESG is not a passing trend; it is central to maintaining organisational strength and competitiveness.

To thrive in this environment, companies must focus on risk, resilience, reputation and returns with a business imperative as the common thread connecting them:

Risks: The evidence is overwhelming and ever-present; climate events and operational disruptions are no longer hypothetical threats but daily realities. The true question is not if risks will materialise, but when.

Resilience: Integrating sustainability throughout the business model builds agility, reduces dependence on volatile resources, enhances appeal for top talent and bolsters preparedness for unexpected shocks. This resilience is essential for long-term survival and success.

Returns: Companies with robust ESG credentials consistently demonstrate an enhanced ability to attract capital and unlock lasting value. Sustainable practices are not about ethical choices, they are about making sound, strategic business decisions that position organisations for growth and stability in a rapidly changing world.

The conversation around ESG may have grown more cautious, with louder political debates and, in some circles, a perception that ESG is a liability rather than a leadership tool. It is not a dirty word. The fundamentals remain unchanged. The climate crisis continues to accelerate and supply chain vulnerabilities persist. The demand for transparency, credible action and strategic sustainability leadership is as relevant, and as necessary, as ever.

Crucially, reducing dependence on external resources is now seen as an opportunity rather than a constraint. Developing a strong local European footprint, through increased production capacity, robust R&D, job creation, resilient supply chains, decarbonisation trajectories and innovation in resource management (spanning both natural and human capital), is emerging as a strategic priority. This approach not only enhances security of supply but also fosters self-determination and resilience in the face of geopolitical and climate-related shocks.

Academic research consistently supports the financial relevance of ESG, but its value must be continually demonstrated in investment analysis to ensure it remains a non-negotiable principle. As we move toward 2026, the emergence of a new ESG paradigm, centered on Energy, Security, and Geostrategy, will define the next phase of sustainable investment. The path forward requires ambition, credibility and innovation, with sustainability firmly positioned as a strategic imperative in an era of ongoing uncertainty.

Examining the ‘E’ of ESG, has regulation helped the transition?

The ‘E’ in ESG, Energy, remains a focal point for investors and policymakers as the world attempts to transition away from carbon-intensive practices. While carbon alignment is still a priority, currently investor sentiment is shifting towards more nuanced tools, such as assessing transition credibility, financing strategy, and policy risk management, rather than just relying on emissions snapshots.

Investor behaviour and government’s role

Political developments, such as the election of Trump in the US, have influenced investor attitudes. A recent study shows that, after the election, average green investment shares dropped as they were perceived as riskier and less profitable. However, investors who opposed the administration’s climate stance increased their green commitments, underscoring a willingness to compensate for government inaction and support the environmental public good. This dynamic shapes how climate risks are priced and modelled.

Ultimately, government incentives remain vital. Without policies that internalise environmental externalities, private climate investment emerges endogenously, but the scale may fall short of collective needs. The future of green finance depends on stakeholders’ ability to combine ambition, credibility, and innovation in a context where sustainability is a strategic imperative amid geopolitical and climate uncertainty.

The regulatory push and its side effects

Regulations such as the EU’s SFDR and Taxonomy have sought to accelerate the energy transition by imposing stricter ESG standards on financial institutions and corporations. Nevertheless, a working paper from the European Central Bank has found that by successfully incentivising banks to divest from companies with poor ESG profiles, that the side effect of such regulations is visible, for example, in the reduction of holdings in battery raw material mining companies, including those producing lithium, cobalt, manganese and nickel. The need for these commodities in the energy transition is undeniable. As EU banks exit, non-EU investors with weaker ESG mandates step in, resulting in an ‘ownership substitution effect’ where the EU’s influence over corporate ESG behaviour is diluted. This paradox highlights a critical challenge: regulations may inadvertently undermine the transition by restricting capital flow to sectors that are key to decarbonisation.

The regulatory landscape raises important questions about the effectiveness of the Taxonomy in supporting the transition. For instance, under SFDR 2.0, exclusions for new fossil fuel projects could result in entire sectors, like oil & gas, being left out of transition strategies, even though these are arguably the sectors most in need of change. This highlights the necessity for ‘transition’ investment strategies to complement conventional ‘impact’ or ‘sustainable’ approaches. Mining companies are crucial for future-facing commodities and should be part of transition funds, provided they adhere to best practices in human rights, environmental impact and business conduct.

Conclusion - sustainability’s future hinges on opportunity and risk

For sustainability to truly resonate with investors, it must be framed as a source of compelling investment opportunity. The language of finance, returns, growth and upside potential, remains the key to attracting attention and capital. As seen in the energy transition and critical mineral sectors, aligning sustainability with resilience, competitiveness and supply chain security creates a powerful narrative that supports both environmental goals and economic interests.

However, the ‘S’ in ESG, social factors, presents a more complex challenge. Unlike the clear growth pathways in energy and materials, social reforms often lack direct, quantifiable investment opportunities. Yet, this does not mean they should be sidelined. Social measures such as labour law reforms, gender equality initiatives, and improvements in corporate governance are increasingly linked to risk mitigation. Companies operating in regions with progressive social standards may be better positioned to manage regulatory, reputational, and operational risks. In a world where investors are ever more conscious of long-term stability, social factors are becoming integral to risk-adjusted performance.

Ultimately, for sustainable finance to regain traction, it must balance the promise of opportunity with the imperative of risk management. The ‘S’ may not always offer the same upside as the ‘E’, but it is essential for building resilient portfolios and future-proofing investments. As the global ESG landscape continues to evolve, stakeholders must recognise that social progress, just like environmental innovation, is a strategic asset. Only by integrating both can we ensure that sustainability is not just a moral imperative, but a business case that commands attention and action.