The debate about whether integrating sustainability in financial products is a niche has died down. With regulators redirecting global financial flows, expansionary fiscal policies, and changing consumer demands, it is no surprise: sustainability is the new norm.
But a major problem is that standard ESG definitions have not yet been established and EU regulatory projects such as the EU taxonomy, MiFID and the Sustainable Finance Disclosure Regulation have not yet been aligned. As a result, the analyses of sustainable research houses and asset managers sometimes differ significantly.
Another problem is the forceful marketing engine. Sustainability has now become so significant that - at least at first glance - there are hundreds of providers of green products and services. Many of the world´s asset managers, banks, stock exchanges, data providers, or rating agencies did not have a single sustainable product just a few years ago, but market themselves as pioneers today: where trillions of hard currency are invested, many are eager to quickly transform themselves from flagship capitalists to environmental angels in the public eye. ESG marketing is in full swing, leaving consumers behind in the green fog.
One topic that has received significant attention is “impact”. For example, one fund company decided to remove an online impact calculator from its website after a consumer protection agency challenged the credibility of its claims and demanded that it be removed. This has raised doubts among investors. Moreover, another major German asset manager has come under public and regulatory scrutiny for making exaggerated sustainability claims about its funds. How many cases remain undetected? I would dare to say that in the absence of unified, consistent standards and due to different criteria being applied, it would be possible to report critically on almost any investment product. The former chief investor of the largest U.S. asset manager even called ESG a “deadly distraction” from the solutions that are actually needed. That's why public skepticism is growing.
Detective work in the green zone
Why is it so hard to judge whether a company is operating sustainable? Here are three examples: A large beverage manufacturer reports low CO2 emissions - clearly: subcontractors handle the CO2-intensive logistics, which are part of its scope 3 emissions. E-commerce companies emit little CO2 themselves - but is their business model of sending products around the world sustainable? An asset management giant propagates climate protection - and at the same time co-finances deforestation, which is contradictory to say the least and calls for industry-specific climate and ESG risk assessment tools - particularly for harmful industries.
But even when looking at the entire value chain from energy generation to the end of a product lifecycle, there is a lack of accurate data. That said, I believe transparent, detailed reporting to the best of our knowledge is nevertheless the right and most important approach.
External, independent ratings can be another solution. Analyzing comprehensive sustainability reports requires time and expertise. Ratings or labels can ensure minimum standards. For the established FNG fund label (“FNG-Siegel”), for example, providers are required to have themselves audited once a year by the University of Hamburg as an independent auditor. Quality standards such as the aforementioned also help create the necessary transparency, which serves a key role.
For example, for the DNB Fund Renewable Energy, a strategy dedicated to investing in the solution providers to climate change, DNB Asset Management has published a 38-page report assessing potential avoided emissions and exposure to the UN Sustainable Development Goals. Additionally, the fund was awarded the best-possible classification by the FNG.
When it comes to transparency, the Scandinavians are by far the most advanced. The Swedish government, for example, began implementing and continuously publishing its sustainability strategy as early as 2001, one of the results of which is that the country now leads the rankings of the most environmentally friendly countries - closely followed by Norway and Denmark. Whether in climate protection, the education system or equal rights - the northern countries are regarded as role models for a modern sustainable society.
The Nordic financial sector is also considered exemplary. Some Scandinavian companies were co-founders of the UN Principles for Responsible Investment in 2006. The UN PRI are considered a guide for the financial industry. After a two-year boom, there are now 4,308 signatories. The Nordics have long focused on demonstrating the impact of investments, their social or environmental impacts. Exclusions are considered an accompanying measure or last resort if active ownership efforts prove unsuccessful after severe breaches have occurred.
For years, the Scandinavians have been actively engaged in dialogues with companies and voting at their annual general meetings, a field that is still quite uncharted in Germany. Such engagement provides portfolio managers with a greater information base for company analysis and investment decisions. Understanding how companies deal with material ESG risks and opportunities can have a decisive impact on stock selection.
ESG and carbon data should be integrated into the portfolio management system. At progressive institutions, they are not only available to all investment professionals, but they use them systematically. Failing to do so entails financial risks and weakens credibility, as is currently being experienced in Germany. Greenwashing does not only damage the reputable sustainable finance segment, but the financial industry as a whole.
Comprehensive monitoring of environment-related risks and opportunities should be implemented as soon as possible. For the sake of product truth and transparency, this data should be made available to investors in sufficient detail. Once again, it is important to say what is actually happening. This will enable investors to decide for themselves whether the investment philosophy in question and the approach chosen meet their own requirements.
One thing is certain: incorporating sustainability into investment decision making is a complex and time-consuming process. Even though this space is evolving rapidly, product providers cannot be expected to already have a full grip on all elements of sustainable investing or to have accomplished their ESG goals by now. Importantly, the financial industry should not make the attempt to create such an image, either. Credible efforts and actions as well as a true and fair reporting are the way to prevent the remaining trust in the financial world from being squandered.
Private capital is critical to delivering the transition to the low carbon economy. But investors must also acknowledge that it is actually the underlying portfolio companies that are delivering the change, and that investors have only a role to play through the way they select companies and which expectations they set. Governments will also continue to have a critical role.
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