This week’ investment roundup looks at how the EU is beginning to address the greenwash challenge and how an increasing focus on nature is shifting perception in the market. New tools, reporting frameworks and engagement strategies mean that carbon is no enough enough to be considered sustainable.
And that’s important as the market perception of what is considered sustainable continues to evolve. There is no longer space for talking without action – markets, investors and consumers want to see transparent and significant action.
That means that sustainability as a new lens for business growth is continuing to drive the markets, encouraging circular thinking and design, embracing the need to understand sources of energy and materials, collaborating with the supply chain and exploring how technology can transform their business – what Cognizant calls deep green sustainability.
Greenwash in products and funds
Greenwash continues to be an issue, both in terms of product and investment, but there are increasing moves to regulate the market and ensure that there is greater transparency in the market.
The EU is making strides, the most obvious of which is the launch of its EU Green Bonds Standard. This forthcoming standard builds on the EU’s announcement that it plans to ban claims of ‘climate neutrality’ by 2026 – basically because no one really understands what that means. Proposed in 2022, the original proposal was to limit use of relatively undefined terms like climate neutral but a plenary recently added the warning on the use of carbon offsets to suggest that a company was delivering ‘green’ products.
The new agreement updates the existing EU list of banned commercial practices and adds to it several problematic marketing habits related to greenwashing and early obsolescence of goods. The aim of the new rules is to protect consumers from misleading practices and help them make better purchasing choices.
The proposal must be agreed by both the full Parliament and the Commission and is expected to be discussed in November. When the directive comes into force, member states will have 24 months to incorporate the new rules into their law.
Reports on ESG funds remain contradictory
There is contradictory data on the importance of ESG funds – there are reports of an outflow of funds from ‘woke’ investments and reports of increased focus on the risk impact of environmental, social and governance challenges. In large part the difference in reporting can be attributed to political perspective, but there is also an issue that the definitions remain unclear.
The European Securities and Markets Authority (ESMA) recently reported that the proportion of investment funds in Europe using ESG-related terms in their find names has grown by more than 4 times over the past 10 years. This is partly because of the launch of new funds and partly due to name changes done to incorporate concepts of sustainability.
ESMA shows that the share of EU UCITS investment funds with ESG words in their name has increased from less than 3% in 2013 to 14% in 2023. It highlighted that fund managers tend to prefer using generic language (‘ESG’, ‘Sustainable’) rather than more specific words. This can make it more difficult for investors to verify that the fund portfolio is in line with the name. This is a challenge that has recently been addressed in the US by the SEC when it changed its Names Rule to protect investors and ensure that at least 80% of a portfolio was aligned with the title of a fund.
This lack of clarity makes it challenging to ascertain exactly what is going on in terms of investment flow and appetite. Morningstar, Inc. (NASDAQ: MORN) is reporting that ESG issues are becoming increasingly material to investors, while Calastone reported that ESG funds suffered their 5th consecutive monthly outflows – suggesting that investors are increasingly turning their backs on the investment lens.
Of course Calastone is reporting on fund flow, while Morningstart is focusing on longer term considerations. Mornginstart published findings from its second annual Voice of the Asset Owner survey, reporting that two of three asset owners (67%) believe ESG has become more material to investment policy in the past five years, with the environment and issues around net-zero emissions cited as key ESG materiality drivers. And while implementation challenges continue to persist, over the respondents reported increasing their allocation to ESG strategies.
The global quantitative survey included 500 asset owners across 11 countries in North America, Europe and APAC with combined assets of approximately $10.7 trillion. Thomas Kuh – Head of ESG Strategy, Morningstar Indexes, said: “The second Morningstar Voice of the Asset Owner survey confirms that institutional investors remain highly committed to integrating ESG factors into their global investments, but challenges related to lack of regulatory clarity and the need for better data and resources continue to persist.”
Nature concern continues to increase in investment decision making
Nature and biodiversity loss is a systemic issue, with direct and indirect effects across the entire economic and financial systems. Not only is there risk from the physical impacts of climate change and a loss of resilience, but there is increasing concern about policy risk too.
In the EU, NGOs have been calling for a Nature Restoration Law – 200 NGOs have issued a call upon all EU Member States, Members of the European Parliament and the European Commission to ensure several key elements are included in the final text of the law. They include: all terrestrial and marine habitats are covered by quantified, time-bound and enforceable targets in and outside Natura 2000 areas; restoration of agricultural ecosystems, complemented by dedicated targets for the restoration of drained peatlands; ensure the law can enter into force immediately, without preconditions for the timely and steady implementation of the restoration targets; and dedicated and additional funding to finance restoration measures. If adopted this will have a significant impact on farming, food and wider agriculture.
This growing concern about physical and policy risk means that companies and investors are increasingly considering, and measuring, the impacts of their business activities on nature, or “natural capital” (the world’s stock of natural assets like air, water, soil, and biodiversity). This includes how impacts to ecosystem services, the benefits nature provides to people, create risks – and opportunities – for their businesses and clients.
In terms of reporting and transparency, the Taskforce on Nature-Related Financial Disclosures (TNFD) recently released its final risk management and disclosure framework for companies and financial institutions. These recommendations are intended to inform better decision-making by companies and investors, to “ultimately contribute to a shift in global financial flows toward nature-positive outcomes.”
Meanwhile for those investors who want to work with their portfolios to effect change, the UN-backed Principles for Responsible Investment (PRI) have now announced they are developing a new collaborative stewardship initiative on nature. The initiative’s objective is for investors to contribute to the goal of halting and reversing biodiversity loss by 2030. This is aligned with the goals and targets of the Kunming-Montreal Global Biodiversity Framework.
The PRI believes that investors are highly exposed to systemic risks like biodiversity loss but that universal owners and long-term investors have a limited ability to diversify their portfolios away from the impacts of such issues. Stewardship activities, particularly when carried out in collaboration with other investors, are an essential tool for managing risk, as well as driving more sustainable real-world outcomes.
The have opened a list for public endorsement, for asset owners, investment managers or service provides to publicly sign the Spring investor expectation statement, signalling their support for the initiative’s objectives and strategy.
While investors can sign-up as an endorser at any time throughout the initiative, the first set of endorsers will be publicly announced in early 2024. Therefore, investors are encouraged to sign-up by 19 January 2024 to be included in this list.
Meanwhile, the Stanford-based Natural Capital Project collaborated with Morgan Stanley’s Institute for Sustainable Investing to develop a new, open-source ecosystem services footprinting tool. TNFD is providing a NatCap case study about this footprinting tool as additional guidance on how to assess nature-related impacts and dependencies (i.e., the ways a business’s operations may depend on nature’s services). The tool can be downloaded for free here.