Democracy and the rule of law is the defining ESG issue of the year

For the past several years, climate has dominated ESG agendas. Rightly so in our view, given that its physical and transition risks are reshaping portfolios and policy alike. But in 2026, one issue has returned to the forefront with unmistakable urgency: governance, and more specifically, the health of democracy and the rule of law.

This is more than a philosophical concern. In my view it is the single most important systemic foundation upon which functioning markets, responsible businesses, and sustainable long-term investment outcomes depend. And today, that foundation is under strain.

Good governance is the best insurance

In the ESG world, governance has recently felt like the quiet sibling – important, but less visible than the headline grabbing climate agenda. Yet governance is the pillar that holds everything else up. Without good governance, political stability, predictable institutions, and an impartial legal system, neither environmental nor social commitments can be reliably delivered.

Without good governance, political stability, predictable institutions, and an impartial legal system, neither environmental nor social commitments can be reliably delivered.

Investors intuitively understand this. Good governance is what transforms corporate promises into corporate performance. But the same logic applies at the macro level. Climate targets do not survive in environments where regulatory decisions swing with political winds. Social progress cannot be safeguarded in societies where the rule of law erodes. When democratic norms weaken, companies find it harder and more expensive to operate and the sustainability agenda becomes harder to implement, monitor, and enforce.

Never underestimate the rule of law

If democracy is the architecture of a resilient and thriving society, then the rule of law is the machinery that keeps the economy running. It is the grease that allows markets to function quietly, consistently, often invisibly.

The rule of law:

• Protects property rights and investment capital
• Ensures contracts are enforceable
• Sets boundaries on political and corporate power
• Creates a level playing field where competition—not favouritism—determines success

These are not abstract ideals. They are the conditions that enable economic growth and innovation. Without them, markets degrade, trust decays, volatility increases and risk premia rise.

We have grown accustomed to this machinery working in the background. For almost 80 years, many economies enjoyed a period of institutional strength that investors came to view as the norm. But norms, if neglected, can corrode. The slow weakening of the rule of law and democratic guardrails – attacks on independent courts, politicisation of public institutions, crackdowns on civil society, ignoring due process – poses a structural risk that markets are only beginning to recognise.

What this means for investors

The events of the past few weeks may feel exceptional, but they are part of a broader trend: rising political volatility, populist backlashes, and unprecedented pressure on democratic institutions.

The events of the past few weeks may feel exceptional, but they are part of a broader trend: rising political volatility, populist backlashes, and unprecedented pressure on democratic institutions.

Companies must now navigate an environment where political risk is no longer peripheral; it is strategic. How they do so will signal to investors the strength of their governance, culture, and long-term resilience.

In the short term, some firms may be tempted by the allure of ‘crony capitalism’ – leveraging political favour for regulatory relief, subsidies, or competitive advantage. But this path is inherently unstable. The benefits may be immediate, but they are fragile. The breakdown of independent institutions and fair legal frameworks ultimately harms growth, reduces investment certainty, and erodes the very conditions businesses need to thrive.

This has real‑world consequences for everyday investors, including:

• More uncertainty in key industries – When governments make unpredictable decisions, sectors such as energy or tech become harder to understand and value. This makes share prices more volatile and can reduce long‑term returns.
• New, unexpected risks – Political shocks or sudden changes in rules can create “out of the blue” market drops that weren’t on investors’ radar before. This may result in negative social impact, particularly for vulnerable people such as low-income savers or pensioners.
• Money flowing into challenging sectors – In turbulent times, investment often shifts toward sectors like defence, which is not necessarily antithetical to ESG goals but requires a more nuanced debate.

When governance is strong, markets price risk more efficiently

I often think of good governance—be it in a company or a country—as an indispensable insurance policy. You don’t notice when it’s working—but you acutely feel its absence when you need it. When governance is strong, markets price risk more efficiently, long-term planning is possible, and corporate sustainability strategies can be implemented with confidence.

But as with any insurance policy, neglecting to pay your dues is perilous. Once trust in institutions deteriorates, the rebuilding process is long, costly, and uncertain.

A critical moment

We are at an inflection point. The political turbulence unfolding globally is a stark reminder that democracy and the rule of law cannot be taken for granted. They are systemic assets—quiet, foundational, and irreplaceable. For investors, recognising their importance is not about ideology. It is about risk, resilience, and the sustainability of returns. For companies, demonstrating an ability to navigate this complex landscape will be one of the clearest indicators of strong governance.

As ESG priorities evolve in 2026, one truth stands out: without healthy democratic institutions and a robust rule of law, sustainable capitalism cannot function.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. The views expressed are those of the Royal London Asset Management at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.