Green investing may have grown in popularity but with this came the risk of “greenwashing” as funds embellished their environmental kudos. This was enabled by a lack of consensus on what green investing actually was. Recent regulatory developments have served to expose this; late last year, Reuters reported that European financial regulators had been uncovering more cases of greenwashing by asset managers keen to cash in on the “booming” demand for sustainable finance.
John Cotter is professor in finance and chairman in quantitative finance at University College Dublin. He says sustainable investment has increased dramatically, with some areas, such as green bonds, growing exponentially.
“Green bonds dominate the issuance of EU bonds, and ESG funds are now experiencing much better performance compared to non-ESG funds,” says Cotter. “In 2021, green firms had better returns on asset performance than brown firms, and the valuation of firms with a green agenda is increasing. This is moving the dial strongly to a tipping point, if it has not passed already.”
When it comes to the drivers behind ESG investing, Cotter points to enhanced climate awareness and the public sector push on the green agenda. The pandemic has also led to more concentration on ESG issues, and these have come to the fore in valuation of firms, he says. “The improved performance of green investments has attracted further interest and flow of funds into these investments.”
Exaggeration of environmental credentials became an issue. According to Cotter, there has historically been a lack of consistency in much of green finance but he says this is narrowing over time. For example, emission reduction targets of firms, which vary widely, may often not be explicitly stated and can have different target years.
“Large firms are making the most inroads here, but still there are a high proportion of large firms – around 90 per cent – who do not have CO2 emission targets.”
Cotter says the emergence of “green fintech” is critical and will play a significant role in achieving environmental sustainability. “Green fintech is important as it allows for greater transparency in setting and meeting green targets. It is also important as it allows for better analysis of information on the green agenda,” he says. “Areas of benefit include the use of green fintech to help investors make informed ESG decisions, the supply of data solutions to support reporting and disclosure, and artificial intelligence tools to analyse company information for the presence of greenwashing.”
Andy Murphy, managing director and head of strategy at Waystone says despite green investments having become mainstream within the funds industry, regulation is still in its nascence. However, the introduction of SFDR (Sustainable Finance Disclosure Regulation) classifications last year has helped trustees to understand the level of ESG integration within funds.
“The framework that monitors and oversees this sector is still relatively new, although additional legislation under the Regulatory Technical Standards (RTS) is due later this year,” says Murphy. This aims to take a closer look at the specifications for the content, methodology and presentation of SFDR disclosure requirements, as well as mandatory templates for pre-contractual and periodic reporting disclosures.
Murphy explains: “Under SFDR, a fund must effectively disclose and assign a category to the fund and the fund’s investment strategy – article 6 funds do not pertain to have any ESG investments or are not advertising themselves as ESG funds. Article 8 funds are, at a very high level, promoters of ESG investing and do strive to find and fund ESG investments, although they are not exclusively mandated to do so, and can therefore invest in to certain non ESG investments. Article 9 funds are the gold banner in terms of ESG investing, whereby sustainable investing is an objective of the fund.”
Tom O’Gorman, head of distribution, Ireland at Legal & General Investment Management (LGIM), says this means asset owners and institutional investors are now clearly defining their position on ESG as both regulatory pressures increase and improvements in ESG data reporting make this more achievable.
“Incorporating these positions will take more time as asset owners assess the ESG fund universe across their portfolio. SFDR classification will assist these decisions as more investors will move to article 8 and article 9 funds. We are seeing some early investors particularly with an impact focus already reshaping their investment portfolios.”