Confused about Sustainable Investing? How come?
In my earlier piece on „Sustainable Investing” I provided some food for thought around the private investor’s options in this space and introduced some investment vehicles that could be interesting for anyone wanting to “do good” while “investing smart” (Green Bonds, Development Bonds, ESG Thematic Equities etc.). That is probably the easy way to go about calming your investment conscience: Labels — let’s face it, we all love labels — big fat rubber stamps that tell us we are doing the right thing by buying this product (here is a list of some: Ecolabels). Be it fair trade coffee, organic carrots, AWA chicken, BCI Cotton or anything else that can get certified, the supermarket will have it. BUT, do the labels food deliver what they promise? Don’t ask me, I’m just a banker. Hence, back to sustainable investing….
Supermarkets and Financial Products
…. well , almost. Let’s stick with our example of the supermarket for a second. The supermarket is a distributor of food products that are labeled. Some of those labels are standardized throughout the entire food industry — nutrition facts for example. You would agree that it is almost impossible to find any food product that does not indicate carbs, protein and fat content on the packaging (the local grandma’s fudge shop excluded). Then there are special labels, like the “glutenfree” (pretty clear), “sugar free” (also, pretty clear) or certain types of ESG labels (nope, not so clear). Unfortunately, those, let’s call them “ESG-labels” are not as standardized as our beloved nutrition facts. “Fair trade” for example can have many certification bodies. So many, in fact, that the #fairworldproject had to publish user guides to explain how to distinguish them (the latest can be found here Fairworld Project).
A completely transparent jungle of standards (Bonds and Equities)
Now, really back to investing: Banks are like supermarkets for financial products, which also have labels (or ratings), mostly — credit and performance which are not always correct (remember the financial crisis?) but at least they are numeric and fairly universal. Unfortunately, Sustainability labels (or standards) for financial products are more in the “fair trade-status” than the “nutrition fact-status”. There are as many acronyms as the alphabet permits to describe what a sustainable investment is. And just as with other products, there are various dimensions that can be certified, depending on the product. For example, a certified green bond, could be certified according to the European Union Green Bond Standards (EU GBS) or the Association of Southeast Asian Nations Green Bond Standards (ASEAN GBS) or the International Capital Market Association (ICMA) … or… you get the point. The same goes for Social Bonds, Sustainability Bonds, ESG Bonds.
Stepping away from Bonds (and yes, I will pick up on the way forward in this space later), let’s have a look at Equities. Equities are even more difficult to standardize since the investment typically is a share of an entire company rather that an act of financing a project that has been defined as “green” in one way or another (Bond). This is where rating agencies (S&P and Dow Jones Sustainability Indices; MCSI; Sustainalytics) and standard setters for ESG reporting (SASB; GRI; TCFD ) come in. They suggest valid, but different ways for companies to report on ESG criteria (e.g. some are looking at environmental materiality and some looking at financial materiality, some are assessing the ESG risk to the company, other the ESG risk to the planet etc.). All of them are attempting to increase transparency for the various stakeholders, including investors. But since there is not universal agreement on how to define and report on corporate activities and their level of sustainability, they are creating a lot of confusion in the markets (which is excellently portrayed in the paper “Aggregate Confusion: The Divergence of ESG Ratings” by F. Berg, J. Kölbel and R. Rigobon) .
To trust or not to trust
Now, where does that leave us? At this point, large investment firms and asset managers with significant data management capacity are able to make sense of the different types of data and consequently are able to follow ESG investment principles (there are also organizations that have come up with those, e.g. PRI). The private investor however is still facing a jungle of information that can get extremely time consuming to make sense of. While he/she could just “believe” whoever he’s banking with, it is concerning that different players will come to different conclusions, which again opens the door for green washing of financial products on every level of the financial services value chain.
To regulate or not to regulate
Many argue, that market forces will eventually lead to a global alignment without regulatory intervention — others are under the impression that we are running out of time (e.g. to reach the 17 SDGs by 2030 or to adhere to the Paris Climate Agreement) and need a regulatory force to “put the hammer down”. The EU Commission has decided to make a start with the EU taxonomy which is defining what a sustainable economic activity is based on the sector. The taxonomy acts as the underlying basis for several regulatory requirements (e.g. MiFIDII, IDD, The disclosure Regulation and the EU Green Bond Standards). While the attempt to standardize the industry is an honorable one, the job is large and the current outcomes of the work of the Technical Expert Group on Sustainable Finance (TEG) are impressive. There are various shortcomings and risks to the current EU approach, which are… a topic for another day… well, blog.
