Contents

Chapter 1. ESG Finance Overview and Global Trends

1.1 Origin and Evolution of ESG

ESG Finance refers to the financial paradigm of integrating non-financial information across three pillars (Environment, Social, Governance) into capital allocation decisions. The term entered the formal vocabulary of international financial markets with the 2006 launch of the United Nations Principles for Responsible Investment (UN PRI)¹. The UN PRI was a voluntary compact signed by twenty leading institutional investors under the leadership of then UN Secretary-General Kofi Annan, and it is widely recognized as the first formal international document to define the ESG acronym in its present sense.

The Paris Agreement, adopted at COP21 in December 2015, marks the second inflection point in ESG finance². Article 2.1(c) of the agreement codifies the obligation of "making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development." With this language, the financial sector was redefined from an external observer of environmental policy into an internal actor with normative duties. The Task Force on Climate-related Financial Disclosures (TCFD), established the same month, issued its Final Recommendations in June 2017, structuring climate-related financial disclosures into four pillars (Governance, Strategy, Risk Management, Metrics and Targets) and eleven recommended disclosures³.

At COP26 in Glasgow in November 2021 the IFRS Foundation announced the formation of the International Sustainability Standards Board (ISSB). On 26 June 2023 the ISSB issued its first two global baseline standards, IFRS S1 (General Requirements) and IFRS S2 (Climate-related Disclosures), with effective dates of 1 January 2024⁴. Throughout this book, these standards are referenced by the simulator tokens IFRS_S1 and IFRS_S2. The launch of the ISSB consolidated the previously fragmented landscape of sustainability disclosure into a single global baseline.

"We recognise that applying these Principles may better align investors with broader objectives of society. Therefore, where consistent with our fiduciary responsibilities, we commit to incorporate ESG issues into investment analysis and decision-making processes." — UN PRI Principle 1 (2006)

1.1.1 Academic Genealogy of the ESG Term

The ESG acronym first appeared in print in the June 2004 report "Who Cares Wins," published by the UN Global Compact. The report was the output of a conference convened by twenty-three global financial institutions, including Deutsche Bank, Goldman Sachs, HSBC, and UBS, and it advanced the proposition that "integrating environmental, social, and governance issues into asset management leads to better societies and at the same time creates more stable and predictable capital markets." Prior to this document, what is today called ESG was dispersed across distinct vocabularies, including Socially Responsible Investment (SRI), Ethical Investment, and Impact Investment.

The "Who Cares Wins" report set forth six recommendations: (i) analysts integrate ESG issues into research; (ii) financial institutions establish ESG integration policies; (iii) asset managers reflect ESG factors in investment decisions; (iv) consultants and rating agencies strengthen ESG analytical capacity; (v) companies publish ESG information in standardized formats; and (vi) regulators encourage ESG disclosure. These six recommendations were directly inherited by the six UN PRI principles in 2006, and their structural footprint remains visible in the ISSB IFRS S1 and S2 standards.

1.1.2 From Socially Responsible Investment to ESG Integration

Traditional Socially Responsible Investment (SRI) relied predominantly on negative screening, excluding industries such as tobacco, weapons, gambling, and fossil fuels from portfolios on ethical grounds. ESG integration, by contrast, deploys positive screening and active engagement, treating ESG factors as material drivers of long-term financial performance to be analyzed both quantitatively and qualitatively. As of the 2024 GSIA dataset, ESG integration accounts for the largest share of sustainable investment assets at approximately 25.2 trillion U.S. dollars, while negative screening and corporate engagement account for approximately 10.5 trillion and 8.7 trillion respectively.

1.2 ESG Investment Market Size

Estimates of the size of ESG assets vary widely across providers because of differences in classification. The Global Sustainable Investment Alliance (GSIA) reported that global sustainable investment assets stood at approximately 30.3 trillion U.S. dollars at year-end 2022, a 14 percent decline from 2020⁵. The decline reflects both the U.S. Securities and Exchange Commission's intensified anti-greenwashing enforcement and a methodological tightening of the GSIA's own classification rules, which stripped the ESG label from a substantial number of previously included funds.

BloombergNEF's Sustainable Finance Outlook 2024 reports that global issuance of sustainable bonds (green, social, sustainability, and sustainability-linked) reached 939.5 billion U.S. dollars in 2023⁶. Of this total, green bonds accounted for 575.6 billion (approximately 61.3 percent), while sustainability-linked bonds (SLBs) fell to 70.0 billion, a 23 percent year-on-year decline. The contraction in the SLB segment is attributed to controversies around "ambition shortfall," that is, the lax design of key performance indicators that allow issuers to avoid coupon step-up penalties, and to the resulting erosion of market confidence.

By region, Europe accounts for approximately 47 percent of sustainable investment assets, followed by the United States at 38 percent, Japan at 8 percent, Canada at 5 percent, and Australia and New Zealand at 2 percent. The simulator standardizes such asset classifications through the ENUMs CLIMATE_FINANCE and SUSTAINABLE_FINANCE to ensure interoperability across tools.

1.2.1 Morningstar Sustainable Investing Landscape 2024

Morningstar's 2024 first-quarter report records global ESG fund net assets at 2.97 trillion U.S. dollars and net inflows of approximately 9 billion in the first quarter, a rebound from net outflows of 2.5 billion in the fourth quarter of 2023. United States ESG funds, however, posted a seventh consecutive quarter of net outflows (cumulative -8.9 billion), in stark contrast to European inflows of 10.2 billion. This regional bifurcation is widely attributed to the influence of the anti-ESG political movement in the United States, particularly state-level legislation in Texas and Florida restricting public pension allocations to ESG-labeled managers.

By product type, actively managed ESG funds account for approximately 56 percent of assets, with passive ESG vehicles (ESG ETFs and index funds) accounting for the remaining 44 percent and growing rapidly. The largest single ESG ETF globally is iShares ESG Aware MSCI USA ETF (ticker ESGU), with approximately 13.8 billion U.S. dollars under management. The simulator models such fund categories in combination with rating tokens such as MSCI_AAA and MSCI_AA.

1.2.2 Green, Social, Sustainability, and Sustainability-Linked Bonds

ESG bonds are conventionally divided into four categories defined by use of proceeds: (i) green bonds for environmental projects; (ii) social bonds for social projects; (iii) sustainability bonds combining environmental and social uses; and (iv) sustainability-linked bonds (SLBs), whose coupons vary with achievement of pre-specified KPIs. The International Capital Market Association (ICMA) Green Bond Principles 2021 articulate four core components: use of proceeds, project evaluation process, management of proceeds, and reporting.

1.3 Comparison of ESG Rating Agencies

ESG ratings of the same firm vary substantially across providers, as the academic literature has repeatedly documented. Berg, Kölbel, and Rigobon at MIT Sloan report that the average pairwise correlation across six leading ESG rating providers is only 0.54, a striking contrast to the near-perfect correlation of approximately 0.99 observed across major credit rating agencies⁷. This rating noise has direct consequences for ESG fund management, green loan pricing, and the regulatory selection of disclosure baselines.

In the simulator notation, MSCI ratings are represented by the seven tokens MSCI_AAA, MSCI_AA, MSCI_A, MSCI_BBB, MSCI_BB, MSCI_B, and MSCI_CCC. The Korean providers are represented by KCGS and SUSTINVEST for inputs that reflect domestic evaluation outcomes.

1.3.1 Four Sources of Rating Noise

Berg and colleagues (2022) decompose ESG rating noise into four sources: (i) scope divergence (differences in the set of issues evaluated; contribution approximately 44 percent); (ii) measurement divergence (differences in the indicators chosen to measure a given issue; approximately 56 percent); (iii) weight divergence (differences in the relative importance assigned to issues; not separately quantified); and (iv) rater effects (subjective judgment applied to the same data; not separately quantified). The dominance of measurement divergence implies that standardization of ESG definitions is more urgent than standardization of data collection per se.

A representative illustration is the board-diversity indicator. MSCI uses a single metric, namely the share of female directors. Sustainalytics constructs a weighted average of four sub-indicators covering gender, ethnicity, nationality, and age. S&P Global additionally evaluates the existence of formal board-independence and diversity policies. As a result, the same firm can receive board-diversity scores that differ by more than thirty points across providers.

1.3.2 Industry-Specific Weighting

MSCI ESG Ratings apply industry-specific weights to ESG issues. Water stress, for example, carries a weight of 30 percent in food, agriculture, and beverage industries but a weight of zero in software. Data security and privacy carry a weight of 20 percent in information technology and financial services but zero in mining and energy. These differential weights are deliberate design choices that situate firms within their industry rather than across industries, and consequently direct comparison of ESG scores across industries is statistically inappropriate.

1.4 Comparison of Global ESG Standards

As of 2024, ESG disclosure standards can be organized into four tiers: (i) general disclosure frameworks (GRI, SASB); (ii) climate-specific frameworks (TCFD, CDP); (iii) the unified baseline (ISSB IFRS S1 and S2); and (iv) jurisdiction-specific mandatory disclosure (EU CSRD, SEC Climate Rule).

The European Union Corporate Sustainability Reporting Directive (CSRD) entered into force in December 2022 and is being applied in phases beginning in 2024⁸. The directive applies to approximately 50,000 entities, a fourfold expansion relative to its predecessor NFRD, and brings non-EU parents with EU subsidiaries having revenue above 150 million euros into scope from 2028. CSRD codifies the principle of double materiality through its twelve European Sustainability Reporting Standards (ESRS), requiring entities to disclose both how ESG factors affect them financially and how their activities affect society and the environment⁹. This contrasts structurally with the single-materiality principle adopted by the ISSB.

The U.S. Securities and Exchange Commission adopted its Climate-Related Disclosures Rule on 6 March 2024¹⁰. The rule requires listed registrants to disclose Scope 1 and Scope 2 greenhouse gas emissions but, in contrast to CSRD, excludes Scope 3 from the mandate. Eleven states, including West Virginia and Texas, together with the U.S. Chamber of Commerce, filed legal challenges almost immediately, and on 4 April 2024 the United States Court of Appeals for the Fifth Circuit issued an administrative stay. The ultimate fate of the rule was unresolved at the time this volume went to press, illustrating the political friction surrounding mandatory ESG disclosure in the United States.

1.5 Greenwashing Risk and Regulatory Tightening

Greenwashing, the practice of overstating environmental performance, is the foremost threat to the credibility of ESG finance. A 2023 report by the European Securities and Markets Authority (ESMA) estimates that approximately 23 percent of funds classified under SFDR Article 8 or Article 9 fail to substantiate their ESG label in practice¹¹. In response, the number of Article 9 (dark-green) funds in the EU fell from 1,141 in the fourth quarter of 2022 to 833 in the first quarter of 2023, a 27 percent reduction in a single quarter, a phenomenon labeled self-downgrading.

This volume classifies climate-related financial risks via the simulator tokens TRANSITION_RISK (transition risk arising from the move to a low-carbon economy), PHYSICAL_RISK (direct physical impacts on assets), LIABILITY_RISK (legal liability arising from climate harm), and STRANDED_ASSET (premature retirement of fossil-fuel assets). These four risk types follow the taxonomy first articulated by Mark Carney, then Governor of the Bank of England, in his Lloyd's of London speech of 29 September 2015.

"We are facing a tragedy of the horizon. The catastrophic impacts of climate change will be felt beyond the traditional horizons of most actors, imposing a cost on future generations that the current generation has no direct incentive to fix." — Mark Carney, Governor of the Bank of England (2015)

1.5.1 SFDR Article 8/9 Classification and Self-Downgrading

The European Union's Sustainable Finance Disclosure Regulation (SFDR, Regulation 2019/2088) classifies financial products into three tiers: Article 6 (no ESG integration), Article 8 (light green; products that promote environmental or social characteristics), and Article 9 (dark green; products with a sustainable investment objective). Article 9 products must invest 100 percent of assets in "sustainable investments" and must disclose the proportion aligned with the EU Taxonomy (EU_TAXONOMY).

In November 2022 the European Commission issued guidance interpreting "sustainable investment" more strictly. As a direct consequence, approximately 308 Article 9 funds reclassified themselves as Article 8 in a single quarter, an exercise of voluntary downgrading driven by the higher compliance burden of retaining the dark-green label. This episode is widely cited as the most consequential immediate effect of the European Union's greenwashing crackdown.

1.5.2 Cases of Greenwashing Enforcement

In May 2022, German authorities executed search warrants at the Frankfurt headquarters of DWS Group, the asset-management subsidiary of Deutsche Bank, on suspicion of greenwashing. The investigation was triggered by an internal complaint from former Chief Sustainability Officer Desiree Fixler, who alleged that DWS materially overstated ESG integration across its approximately 459 billion euros of self-described ESG assets. In September 2023 the U.S. SEC imposed a 19 million U.S. dollar fine on DWS for greenwashing-related disclosures, the first such SEC penalty against an asset manager and a precedent-setting enforcement action.

1.6 Core Vocabulary of ESG Finance (Simulator ENUM Mapping)

All code examples, tables, and simulator inputs in this volume are normalized to the following ENUM vocabulary. ENUM tokens follow underscore-separated uppercase form, and inline references appear as identifier.

The ENUM scheme is designed to cover the core data points of ISSB IFRS S1 and S2, the twelve EU ESRS topical standards, and the universal disclosures of GRI Standards 2021. The simulator anchors evaluation context through explicit declarations such as STANDARD: ISSB or STANDARD: GRI, allowing parallel comparison of outcomes when different standards are applied to the same dataset.

1.A Note on Korean Edition Content

The Korean edition of this volume includes a dedicated section "Korean ESG Finance Infrastructure," covering the Republic of Korea's regulatory framework, the Korea Exchange (KRX) ESG market segment, domestic rating agencies (KCGS and Sustinvest), the National Pension Service Stewardship Code, the K-Taxonomy and K-ESG guidelines, and ESG bond issuance by major financial groups (KB, Shinhan, Woori, Hana). The English edition treats Korean infrastructure as one component of the broader Asia-Pacific landscape and references it where comparative analysis is material.

For readers focused on Korean policy and market data, the Korean edition section 1.A presents the Financial Services Commission's ESG Disclosure Roadmap 2024-2030, including its tiered timelines (firms above KRW 2 trillion in assets from 2026; KRW 500 billion from 2029; entire KOSPI from 2030). The simulator includes a K_TAXONOMY_2024 dataset bundled in the GitHub repository so that English-edition readers can reproduce Korean-specific scenarios without translating the source materials.

弘益人間 (Hongik Ingan) — Benefit All Humanity