Green Investment Rules – The State Of Play

ESG and climate-themed investing has taken off massively in the last few years. An increasing focus on climate issues, along with a global pandemic, have seen sustainable and responsible investing become a fundamental element of the investment approach across asset classes. And the move to implement ESG policies has been driven not just by legislation but by investor appetite.

The recent COP 26 summit generated plenty of dialogue on how the asset management industry and capital markets are pivoting towards green investment. At the event, more than 450 financial institutions in 45 countries signed up to a pledge to limit greenhouse gas emissions and incorporate carbon emissions into their investment decisions.

Disclosure, reporting and governance standards have struggled to catch up with the move, and in their absence, a wide range of measurements have emerged, leading to poor transparency for investors and the rise of greenwashing. Greenwashing is a form of spin whereby green marketing is deceptively used to persuade the public that an organisation’s products, aims and policies are environmentally friendly.

“Solutions for independent validation of ESG strategies based on independent data sources are set to become a valuable tool in a market driven by reputation.”

Former Bank of England governor Mark Carney, speaking at COP 26, said that the finance industry must introduce strict climate stress testing as well as frameworks to handle stranded assets responsibly. Solutions for independent validation of ESG strategies based on independent data sources are set to become a valuable tool in a market driven by reputation.

The EU is aiming to create clarity around what is to be considered as ESG and to impose common reporting standards vis its Taxonomy and the Sustainable Finance Disclosure Regulation (SFDR). The Taxonomy is a classification system establishing a list of environmentally sustainable economic activities, while SFDR is a set of rules aiming to make the sustainability profile of funds more comparable and better understood by end-investors.

On 22 October, the final draft rules for financial product disclosures under SFDR were published by the European Supervisory Authorities in their ‘Final Report on Draft Regulatory Technical Standards’. This final draft aims to create a single rulebook for sustainability-related disclosures for SFDR pre-contractual and periodic product disclosures, including Taxonomy-related product disclosures.

Although Taxonomy and SFDR won’t take effect until next July, there is a lot of detail in the requirements which will need consideration and planning for asset management firms looking to promote products that have sustainability themes and objectives. This EU regulatory package should prompt the industry to review ESG policies and revamp data analytics and reporting capabilities.

“Also in October, the UK government laid out its ambition to green the country’s financial system, aligning it with the commitment to achieve net zero emissions by 2050.”

In a policy paper called Greening Finance: A Roadmap to Sustainable Investing, the Treasury said that the move towards a sustainable finance market would involve three stages: ensuring decision-useful information on sustainability is available to decision-makers; making this information a part of daily business and financial decisions; and shifting financial flows to align with a net-zero and nature-positive economy.

These requirements are to be integrated across the economy, and investment managers, financial services firms and corporates must report consistent information on sustainability. The regime will blend existing disclosure requirements with new requirements such as reporting of environmental impact. In line with efforts being taken by other regulators to minimise greenwashing, firms will have to substantiate sustainability claims.

But there more than 30 taxonomies on green investment being compiled by governments across the world. The International Platform on Sustainable Finance, whose members include the EU, Britain, Canada and Japan, will publish a report on the common features of existing taxonomies to create a shared reference for how different countries are defining green investments.

A European Commission spokesperson has said that taxonomies should share key features, including alignment with the Paris Agreement. But with major economies set on their own proposals, and the US not planning one at all, some asset managers are doubtful on international coordination, even on the basic design features of taxonomies.

The EU’s taxonomy looks likely to be the most comprehensive and stringent when it launches next year. The system will set specific criteria on emissions and other metrics that each economic activity must meet to be classed as a green investment, though there are still gaps to fill, and it remains to seen whether gas and nuclear energy will be included.

It’s a bit of a case of ‘watch this space’ in terms of the regulations, but the shift to green investment is well under way. The market for ESG investments has grown dramatically. Businesses and financial institutions are having to respond to the challenge amid high demand for sustainable products. In the UK, studies have found that as much as 70% of the public want their money to go towards making a positive difference to people or planet!