Investments in sustainable funds in Europe are set to outnumber conventional funds over the next five years, as growing investor focus on risks such as climate change and social inequality pushes Environmental, Social, and Governance (ESG) into the mainstream.
Research published by PwC in December forecasts that ESG funds will increase their share of the European fund sector from 15% to 57% by 2025. More than 75% of the European institutional investors PwC surveyed said they plan to stop buying European non-ESG products within the next two years.
However, as ESG becomes an established component of the investment mainstream, experts warn that abuse of the concept is widespread and without a means to better police the way funds are branded, ESG can be little more than marketing puff. “We’ve seen a real sea change in enthusiasm for ESG, but the market needs some rigour about what ESG actually means,” says Richard Spencer, Director of ICAEW Technical Thought Leadership.
“Suddenly investors are demanding ESG-compliant funds but how can asset managers be sure that the funds they create are ESG-compliant?” asks Zsuzsanna Schiff, Manager Auditing and Reporting in ICAEW’s Financial Services Faculty. “How can they consistently trust the information they are given and that the good intentions translate into matching actions?”
With that in mind, the most rigorous effort yet to provide structure to the market came into force on 10 March when the EU introduced a new Sustainable Finance Disclosure Rule (SFDR) that effectively seeks to categorise investment products as sustainable and non-sustainable. It provides a toolkit designed for use by Member states and EU institutions when setting rules about financial products and corporate bonds for assessing whether a financial product or business is environmentally sustainable.
Although it will not apply until January 2022 at the earliest, this EU Taxonomy Regulation introduces a new reporting requirement for certain larger entities in the EU and EU parts of UK groups that fall into scope, forcing them to disclose three new tables, analysing turnover, capex and opex by ‘economic activity’ and ‘environmental objective’.
In the UK, plans for a taxonomy are also progressing after BEIS launched a consultation on its ambition to introduce mandatory climate-related financial disclosures by large organisations in April 2022. Spencer welcomes moves to beef up regulation, but taxonomies aren’t enough in themselves to instil meaningful progress, he warns.
“Our experience of COVID-19 has pushed sustainability into the mainstream. We hear of a green and fair recovery everywhere and the public mood is focused on corporate behaviour. However, what we need to see is that ambition translated into action”, Spencer warns. “Presently ESG focuses on material risks rather than environmental or social impacts”.
Markets need to be able to trust the story a business tells of its sustainability risks and the impacts it has had, and that means bringing rigour and definition to ESG, Spencer says. “We also tend to focus on the reporting of ESG, but to be meaningful, this had to be rooted in practice. It has got to be embedded in an organisation’s decision-making. The framework of the Task Force on Climate-related Financial Disclosures (TCFD) is a decent piece of guidance because it relates good disclosure to practice.”
The starting point must be understanding your dependencies on nature and society, which places them as strategically important to the business, rather than a sideshow. It is recognising that business success rests on thriving social and natural systems. Having a positive impact on nature and society is not about being ‘nice’; it’s survival.
This has to be based in the science, Schiff agrees. “People still think this is about plastic cups. The realisation that this is a real risk for an organisation still hasn’t sunk in. It may not be immediately obvious that financial services is the most exposed sector but think about all the clients they lend to and the companies they insure. They are absolutely instrumental in pushing these efforts through.”
But a change of tack will require a monumental effort, Spencer concedes. “For many organisations, it’s too difficult a question to ask, because for many companies, if they looked at embracing the costs that they’ve externalised to society and nature, they would see their business models are flawed and failing. It’s not just about doing what you do better, it’s about changing the way you do things.”
Instead subscribing to the ignorance is bliss mantra is easier, not least because mechanisms to hold organisations to account on ESG remain very much a work in progress.
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