Would sustainable and responsible investment be an enabler or a drag?
The European Commission's objective is to increase the current growth in sustainable finance. However, regulation is necessary and more welcome now than ever. Without a fair explanation on how to deal with accurate data and appropriate indices, it will be difficult to manage ESG asset portfolios efficiently.
Sustainable finance is the provision of finance to investments that take into account specific environmental, social and governance ("ESG") considerations.
SRI regulations, where are we now?
In 2018, the Commission published three legislative proposals aimed at the following measures:
create an EU sustainable finance taxonomy;
make disclosures relating to sustainable investments and sustainability risks clearer;
establish low-carbon benchmarks.
Regulation is necessary, and is more welcome now than ever.
On the one hand, it will force asset managers to make a stronger shift towards other investments looking at ESG factors and force them to comply with a new regulatory investment policy. On the other hand, the regulation will offer new business opportunities and solutions for investors who increasingly give due consideration to ‘green’ investments. However, regulation proposals so far do not solve the biggest, critical and most important challenge: the lack of data to deal efficiently with ESG factors. In other words, how to ensure or guarantee that a company or an investment is 100% ESG. For instance, regarding investment made in emerging countries without a clear database, asset managers and asset servicers will have to perform on-site visits, expanding the scope of their due-diligence process. On the opposite side, for investments carried out in regulated, recognised and open-ended financial markets, data need to incorporate reliable ESG criteria that are easily comparable.
Ideally, Europe should set its own European rating agency dedicated to sustainable and social investments. This would enable comparison of the behavior of a company amongst its peers within the same financial sector. The mindset of people/investors and companies will continue to evolve. A change of attitude and/or in the way of investing is therefore expected. Education and the increasing campaigns sensitising us to environmental impacts are also the key drivers. However so-called ‘green’ investment can still be expensive today. “I want green electricity as long as it is cheaper.”
Going beyond regulations
Another tricky consideration is that E (environment) can be sometimes in opposition to S (Social). “Am I E responsible if I carry on driving a big 4X4 car and/or carry on smoking and throwing cigarette butts on the ground?” Regulation is not enough, even though it is necessary to move Europe out of the traditional lines of investment and code of conduct. Without a fair explanation on how to deal with accurate data and appropriate indices, it will be difficult to manage ESG asset portfolios efficiently. The process of managing ESG factors and ensuring that investments are ESG compliant will remain subject to broad interpretation with deep, cumbersome and manual analyses. Today this means a ‘new’ cost that is unpredictable and largely variable without truly knowing if, at the end of the day, a company is meeting ESG requirements.
It is also important to agree on a definition of ESG. The existing ESG scope that consists of taking into consideration environmental, social ESG and governance factors is saturated with terminologies and different types of strategies.
Once we have a clear and precise methods, we will be able to focus on the objective of those investments.What do we intend to achieve? Our European institutions have launched a number of consultation papers (CP) aimed at institutionalising ESG within each EC’s regulation in the short term. All CPs on sustainable finance should give some raw material to the Commission’s action plan in the area of securities trading, investment funds and credit rating agencies. The first two CPs seek technical advice on how to integrate sustainability factors and risks within AIFM & UCITS directives and MiFID II. The third CP focuses more on guidelines to be adopted by credit rating agencies on the quality and consistency of information linked to ESG factors. Each of those consultations contains between 30 and 40 pages of questions. Received answers will be communicated, analysed and discussed in order to enhance the Commission’s action plan.
Most of us agree on the necessity of investing by strongly and seriously taking those ESG factors into account. However, being pragmatic, it will take to achieve the EC's objective regarding sustainable finance. There is still lobbying coming from companies, investors and countries to slow down or block the current process because they are afraid of losing business and it is costly. Climate action is one of those examples. Last but not least, as we usually say, sometimes there could be an opposition or an incompatibility between the “E” factor and “S” factor. Whilst the shutting down of an activity may be excellent in terms of improving the environment, it could be perceived as bad for the social factor in terms of job losses.
We ultimately need to find a way of balancing the two and ensuring that the “E” factor creates economic growth and new jobs in Europe without jeopardising the social ecosystem.
Jean-Pierre has 25 years of experience in the investment funds industry. Prior to joining SGSS in 2009, he held several senior positions in collective investment, custody and fund administration, worked as consultant for 3 years and served as director for several fund management companies and funds. He is a regular speaker at international seminars and conferences and was involved in MiFIDII workshops organised by Markus FERBER at the European Parliament in 2015 and 2016.