8 December 2022

A stewardship code for the EU?

Regulation will boost fund naming consistency and disclosures but more work is needed to ensure EU rules impact the real economy, speakers told a webinar hosted by Environmental Finance. Michael Hurley reports

The EU's ambitious sustainable finance package of regulation is an impressive feat – but more work is necessary to ensure its impact is not limited to a 'green' corner of the bloc's financial markets, according to speakers on a webinar, titled 'Can regulation prevent greenwashing?'

Asked whether current EU regulation is achieving its aim of reducing greenwashing, Meg Brown, chief product & marketing officer at Impax Asset Management, said the fund level disclosure requirements under the EU's Sustainable Finance Disclosure Regulation (SFDR) "is certainly cutting back on poorly positioned funds".

"The discipline of having to have your disclosures signed off by a board a fund board with legal advice is bringing so much more rigour into the marketing and positioning of these funds, and in future the naming of funds.

"For managers who have been cautious and strict about their marketing approach and their naming conventions, this is a massive relief."

However, she questioned the extent to which the current rules on disclosure are actually leading investors to change their investment decision to prioritise sustainable objectives.

Renato Coelho, research & innovation manager at Clarity AI, said research by the data company had found that, of 750 funds self-identified as 'Article 9' under SFDR – so-called 'dark green' funds that target sustainability objectives as defined by the taxonomy – "the great majority of those funds had at least 10% of their investments in companies that did significant harm" to sustainability objectives.

Coelho suggested that fund managers may not have been intentionally avoiding reporting exposures to companies harming sustainability objectives, but the templates they were given by the EU to report against did not always capture such harms.

Thomas Willman, senior product specialist for regulation at Clarity AI, said the company had developed a product to help investors better understand "if their investments are sustainable or not".

Brunno Maradei, global head of responsible investment at Aegon Asset Management, called the EU's mission to define a list of sustainable activities, by way of its taxonomy, "a massive undertaking ... it's phenomenal that they've gone as far as they have".

"The other positive is that it focuses the industry ... on a few sustainability performance metrics. The 'principle adverse impact' indicators are going to become a de facto kind of accounting standard," he said, in reference to indicators fund managers will have to provide information on to show they are not negatively impacting EU sustainability objectives.

However, he warned that there is a risk that, if the EU does not add to its sustainable finance regulatory framework to ensure its rules encourage a whole economy transition, it could cause unintended damage.

"An unfinished project is really dangerous," Maradei said. "It could potentially add massively to the costs of the end investors and to the confusion in the market ... if we don't finish it properly.

"What's missing is ... an honest conversation about what do clients need to be protected from [and] what are their objectives. For instance, we haven't really got an honest conversation about the impact of capital allocation and global liquid capital markets."

He said the Paris-Aligned Benchmark rules in EU regulation that set decarbonisation thresholds for climate-themed indexes to meet if they are to be labelled 'Paris-aligned' are one example of this.

"If we all allocated to Paris-aligned benchmarks tomorrow, it would not necessarily mean that we will achieve net zero emissions by 2050. And there you go: you've already got greenwashing, potentially, theoretically, by interpretations baked into the legislation. Emissions could increase if polluting assets simply move to private hands," as they are sold by investors moving assets to Paris-Aligned Benchmarks.

"What's missing is ... an honest conversation about what do clients need to be protected from [and] what are their objectives"

Maradei said investors "do have a role in achieving real world change, but they can't do it alone".

He said regulation that encourages transition in the real economy will also be needed.

However, he said there has, so far, been too little regulatory attention where investors are more likely to achieve impact, through engagement with companies and countries.

"In the UK, the Stewardship Code is great at focusing everybody on how to get a good assessment of stewardship activities. You don't see that focus at all in the [EU] legislation.

"We need to give a lot more attention to how investors are behaving once they actually build portfolios, and how do they behave as owners of the balance sheet of companies. Are they helping to push companies in the right direction in terms of sustainable business practices?

"Is it appropriate for me to be calling myself a responsible investor, and then not paying any attention to the company that I've invested in, by not voting my stocks, by not talking to companies that I have bought bonds from?"

Meanwhile, Impax's Brown said it would be necessary to ensure interoperability between EU sustainable finance rules and those being developed in the UK, US and Asia.

"Global asset managers selling the same portfolio in different markets want to be able to describe it in the same way to those different markets," she said.

'Can regulation prevent greenwashing?' was hosted by Environmental Finance and sponsored by Clarity AI.

A recording of the webinar will shortly be available here to watch on replay.