Despite the challenges, the goal is to build a greener, more sustainable future, but it cannot be done without the weight of financial market participants being fully committed.
Today, country and corporate carbon reduction plans are still far short of the 1.5C target under the Paris agreement. There is a need for a further $1.6tn (£1.2tn) to $3.8tn a year to finance the energy transition.
What’s more, Covid-19 has exacerbated socio-economic inequalities. Private investment is needed to fund the transition to a climate-neutral and fair economy, complementing capital already committed by governments.
But mobilisation of the financial sector is underway. Cop26 saw 450 financial institutions, representing $130tn in capital, committing to transforming the economy and achieving net zero by 2050.
Indeed, new sustainable finance legislations are proliferating. One is the 2018 EU action plan on sustainable finance; it aims to see the EU carbon neutral by 2050. The action plan applies to asset managers, pension funds, EU banks and insurers, among others.
Private investment is needed to fund the transition to a climate-neutral and fair economy, complementing capital already committed by governmentsAsset managers should welcome this initiative because it provides clarity and transparency on a range of sustainability measures to investors, financial institutions, businesses and issuers, helping them make informed decisions on sustainable investment.
Potential of the EU plan
The EU action plan is a series of policy building blocks that together build a favourable environment for sustainable investments. The building blocks, with different implementation deadlines, are:
1. EU taxonomy regulation
This determines which economic activities are environmentally sustainable. It helps investors, companies and policymakers identify activities that are deemed to make substantial contributions to environmental objectives and which help to finance the transition to a more sustainable economy.
The EU taxonomy defines criteria for a given activity to reach one environmentally sustainable objective, such as climate mitigation, but also to not significantly harm any other objective, such as the protection of biodiversity.
2. The corporate sustainability reporting directive (CSRD)
This amends the existing non-financial reporting framework, extending the scope to all large companies and all listed companies, requiring additional third-party verification, and additional reporting requirements.
This is based on the 'double materiality' principle: a company shall disclose the environmental, social or governance factors that can materially impact its value and how the company impacts the environment, social matters or human rights.
3. The sustainable finance disclosure regulation
This supplements current rules governing the public disclosures of financial products. Managers have to disclose the sustainability risks of their investment process; the metrics used to assess ESG factors; the objective in terms of sustainable environmental and social investments; and how investment decisions reached these objectives and took into account the principal negative effects on sustainability factors.
The SFDR applies directly to financial market participants and raises the bar for investment products, especially those seeking to promote ESG credentials (article 8 funds) and those with ESG objectives (article 9 funds) by setting a framework of reporting standards.
This has triggered a significant number of funds and strategies to upgrade to article 8 once these requirements were met. ESG assets in Europe now amount to $5.2tn across nearly 8,000 funds. ESG funds represented 25 per cent of the total number of products, 33 per cent of assets, and 18 per cent of flows in the region.
The existing EU benchmarks regulation has been amended in light of the EU action plan. All investment benchmarks will have to disclose if, and how, they incorporate ESG criteria into their processes.
Plus, new standards for carbon products have also been created with two types of climate benchmarks aimed at helping investors understand the carbon impact of their investments. New categories of low-carbon benchmarks include the EU climate-transition benchmarks and the EU Paris-aligned benchmarks.
ESG considerations will also have to be included in investment advice on investment funds and insurance-linked investments. Mifid II and the insurance intermediation directive have been amended accordingly.
While asset managers in the EU generally have a fiduciary duty to act in the interests of investors, the EU is now explicitly incorporating ESG considerations into these obligations.
The 2018 sustainable finance action plan has launched almost all its planned initiatives. Some are fully applicable now, while others need a longer timeline for full implementation. For instance, the taxonomy regulation will be implemented gradually as the scope of economic activities and sustainable objectives continues to be extended to the end of 2022.
Reporting by companies under taxonomy and CSRD shall reach full completion by 2024-25. SFDR was implemented in March 2021, but additional disclosures will follow in 2022 and 2023.
Decisive moment
We are at a decisive and unique moment in the history of sustainable finance. Sustainable finance is moving from a niche sector to a standardised and regulated environment. Challenges remain for policymakers and regulators, countries and financial market participants, and for corporations that have to implement the new policies.
Regulators also need to better integrate the social dimension into the sustainable finance agenda, notably through the extension of the scope of the EU taxonomy to social objectives.
Despite the challenges, these regulations will accelerate the mobilisation of sustainable finance, reinforce EU leadership in this area, and be an example for regulators across the world.
Sustainable finance is a fast-moving environment and we must not lose sight of the end goal: to build a greener, more sustainable future, with change happening in the real economy.
Elodie Laugel is chief responsible investment officer at Amundi
