Investing in green finance
Institutional investors have one topic on their mind when the climate issue is raised, which can be summed up in two words: environmental indicators. How do you implement them? What difficulties are encountered? When will a European standard be introduced?
In 2011, 195 countries and the European Union committed to reaching an international agreement in 2015 to limit global warming to 1.5–2°C compared with the pre-industrial era: this was the goal of COP21.
Last November, the US – the world's largest economy and second-largest emitter of greenhouse gases after China – sent the United Nations formal notice of its withdrawal from the deal signed in 2015. The withdrawal will become effective one year following the notice. The US has justified the move by saying it does not want to follow rules which it sees as "an unfair economic burden imposed on American workers, businesses and taxpayers", according to a statement by US Secretary of State Mike Pompeo.
Europe moves forward, even without its powerful partner
Following this agreement, the European Commission initiated consultations at the end of 2017 aimed at measuring asset managers' and institutional investors' sensitivity to ESG criteria and climate-related factors. The goal, after this impact analysis, is to pave the way for a regulatory taxonomy that will promote green finance.
At the same time, France and Germany are pushing for nuclear power and gas to not be excluded from sustainable energy classification, which initially excluded them. A significant portion of the economy of these two countries depends on activities linked to these energy sources.
Meanwhile, a Greenpeace study1 shows that four major British banks have continued to finance the coal industry since the Paris Agreement, despite the sector's promises to back cleaner energies. Given this context, will we manage to bring coal financing to an end and meet the goal of limiting global warming to 1.5°C?
Noteworthy progress was achieved on 18 December last year with the signature of the agreement between the European Parliament and the European Council on creating a classification system for sustainable investment activities (the taxonomy). This agreement, which highlights the EU's commitment to implementing the Paris Agreement, aims to create a common language that enables regulators and investors to compare companies. This means these businesses will need to meet transparency obligations.
Listed companies with over 500 employees will have to declare the portion of revenue generated from green activities and the percentage of their investments in so-called "transition" activities. A "transition" activity includes, for example, manufacturing petrol-powered cars that pollute less than those in the first green category of activities fully compatible with the Paris Agreement.
The taxonomy also covers financial products such as collective investment schemes, life insurance and discretionary management portfolios. These products will have to publicly report their information relating to the green category of investments compatible with the first green category of activities listed in the Paris Agreement.
The European Green Deal
On the side-lines of this agreement, the European Commission unveiled its European Green Deal last December, which encompasses every area of the economy and defines the process for making Europe the first climate-neutral continent by 2050.
The Green deal is also an integral part of the Commission's strategy, which aims to implement the United Nations programme on biodiversity, the climate and strengthening its green diplomacy.
This is merely the first stage, and there is still a long way to go to achieve the goal at hand. The regulatory taxonomy, which will take into account the ESG (Environmental, Social and Governance) criteria of green finance, including concrete pro-climate actions, is expected to be published by the end of 2021 and enter into force at the end of 2022, in accordance with the regulatory timetable and the roadmap established by the European Commission.
The ESG challenges are both broad and complex. Once a clear definition is agreed upon by combining various methodologies, the challenge is to obtain the right data, particularly in emerging countries. If European companies that undertake sustainable investments can receive financing from the European Investment Bank (EIB) in the form of loans at preferential interest rates, the EIB has to be able to do the same in developing countries. However, this is a challenge considering the reliability of available ESG indicators in these countries. There is no stock market index that specifically indicates whether an investment or company properly meets ESG criteria. The difficulty lies in the lack of data and transparency from the companies established there. In practice, this raises the question of how to verify that a company meets pollution or ESG criteria without visiting it in person.
Two new regulations
Pending universal indices to be released, two regulations from the European Parliament and Council were published at the end of November.
The first concerns the publication of sustainability information in the financial services sector, which will enter into force on 10 March 2021. This information will provide transparency for the integration of sustainability risks. It will also indicate the negative impacts and the compensation policies influencing investment decisions and/or the return on the financial products made available. By 30 December 2020 at the latest, the Commission will assess, among others, whether or not the average number of employees should continue to be included. It will also assess whether the lack of data and the quality of this data on indicators, as defined, enables said regulation to function properly.
The second regulation modifies a previous regulation (2016/1011 of 27 November 2019) concerning the EU's "climate transition" and "Paris Agreement" reference indices, and the publication of sustainability information for the reference indices.
The latest developments show that the EU is determined to establish a regulation for sustainable finance. EU Commission President Ursula Von der Leyen intends to implement a "new growth strategy that gives more back than it takes away"2. Demand from investors – whether European private citizens or institutional investors – to invest in environmentally-friendly financial products is growing.
Once Europe has defined the framework of its sustainable economy, asset managers will have no other choice than to fall in line.