Delivering on sustainability goals requires a move away from traditional investment approaches

Sustainable finance has been riding high in the news this past year. We saw unprecedented COP26 pledges by financial intermediaries and we saw sustainable bond issuance hitting the $1trn mark for the first time. Despite the ongoing global pandemic, 2021 was a record year for ESG investing, with an estimated $120bn directed to sustainable investments.

Yet, what should – at first glance – be cause for rejoicing has led to a fierce debate over the value of ESG finance and its true impact. There’s a new fundamental concern in financial circles and it grates against the ears: greenwashing.

In recent weeks, Deutsche Bank’s DWS unit delisted some 75% of its ESG assets after facing questions about rating validity. Banks that signed on to the Glasgow Financial Alliance for Net Zero following COP 26 face pushback for loopholes permitting coal investments until next year. And EU taxonomy discussions over the “green” labelling of nuclear and gas energy have led to a diplomatic tussle between member states.

These headlines prompted Robert Ophèle, chairman of the French financial supervisory authority, to issue a rare rebuke of current EU ESG rules, saying they ‘’almost invite greenwashing’’. He singled out the Sustainable Finance Disclosure Regulation’s articles 8 and 9 governing fund categorisation for their loose, catch-all wording. According to Ophèle, “SFDR doesn’t provide for any harmonisation in the European fund landscape.”

Asset Managers Want the Right Tools to Support the Green Transition

These doubts culminated last month just as we at FIA EPTA, the association for European Market Makers, published a report on the pitfalls of traditional approaches to ESG investing and necessary reforms. This study of global asset managers, unsurprisingly, reveals a growing enthusiasm for sustainable investments and a determination on the part of financial actors to drive the green transition forward. However, with mistrust of ESG impact rising in tandem with greenwashing concerns, this momentum risks being undercut unless more principles-based and outcome-focused approaches are adopted.

The report identifies two main concerns:

1. Greenwashing risks caused by incomplete or deficient ESG data;
2. And, in parallel, over-reliance on traditional exclusions-based investing, which can cause asset inflation.

To address these, asset managers need new ways to generate and manage better actionable data – and insights – that help reveal the full sustainability story about potential investments. At present, they must rely on spotty data and rating criteria that vary wildly between jurisdictions.

“As investment strategies pivot away from commercial concerns to meeting broader SDG objectives, the web of complexity is increasing,” said report author Rebecca Healey. “Understanding exactly what investment you are making, and with whom, has never been more critical.”

Asset managers are calling on governments and regulators to set standardised guidelines and to create “data pools” providing a one-stop shop for sustainability information. This would drive investor confidence in ESG investments, knowing their impact is measurable and reported.

Our report also finds a new, broader concept of ‘value’ is needed, which reflects more than just commercial outcomes and recognises other factors, for example, alignment to the UN’s Sustainable Development Goals (SDGs). While asset managers have a fiduciary duty to provide financial returns, many also hope to see sustainability be recognised as a valuable outcome in itself.

There Are Many Investment Paths to Sustainability

Industry and governments will need to lead a concerted global effort to measure ESG impact – recognising the many forms “impact” can take. Unfortunately, recent regulatory initiatives have focused on exclusionary policies barring investments in “brown” industries from being recognised as sustainable. This runs the risk of becoming a blanket ban, barring ESG-minded investors from engaging with entire industries. It is also giving up on the improvement potential of “brown” companies.

In the words of a Head of Sustainability for a large global asset manager: “Exclusion policies are too much of a blunt tool. A better outcome would be for me to invest in a company with a low ESG score today but with the objective of becoming a good ESG performer in the future. What happens to those that are excluded from the indices?”

To avoid the multiplication of greenwashing accusations on one end and an arbitrary blacklisting of industries on the other, the report suggests accepting multiple routes to sustainability. This means recognising that ESG investment strategies can look different yet reach the same goals.

Partnership for a Better Tomorrow

In conclusion, our report’s encouraging takeaway is that asset managers are ready and willing to advance the green transition and want to partner in this effort with governments and regulators. They call for greater harmonisation of evaluation approaches and access to better, more granular data. This data should come from providers that are regulated like credit reference agencies. And investors believe they should be allowed choice in their investment approaches, as long as sustainable development is achieved and recorded in data. The hope for a singular focus on outcomes to drive the next wave of sustainable investments.

There is a real opportunity for the financial industry and governments to partner on a new, more impactful approach to ESG investing. It’s up to us to drive this collaboration forward, looking to build a more sustainable world for all.