The asset-management industry plays many roles. An increasingly important one is contributing to the greening of the financial system. This means integrating environmental, social and corporate-governance (ESG) and long-term-sustainability issues such as climate risk into investment strategy, risk management, asset allocation, governance and stewardship activities. Investing in good corporate citizens can make a lot of financial sense. For instance, in the age of Twitter and consumer boycotts, it is worth thinking about all these issues before a company, which you may be invested in, is faced with a troublesome situation.
Financial regulators around the world are increasingly focusing on financial institutions' capabilities, preparedness and actions to manage climate-change and broader sustainability risks. The idea is to support investment in low-carbon and resource-efficient technologies and to foster a longer-term outlook. This trend gathered momentum in September 2015 when Bank of England Governor Mark Carney described climate change as a threat to financial stability. The same year, the G20 created a private-sector taskforce led by Michael Bloomberg. It recommended how companies and financial institutions should improve climate-related financial disclosures.
In Europe, sustainable finance will be given added impetus thanks to the European Commission's Sustainable Finance Action Plan (EU SFAP). In addition, 15 central banks are now members of the Network for Greening the Financial System , aiming to share best practices on supervision, the macro-financial dimension of climate and environmental risks, and ways to scale up green financing . Moreover, twenty insurance regulators are also sharing best practices through the Sustainable Insurance Forum . As a result, since 2015, central banks, pension funds and bank and insurance regulators have become new key actors accelerating the financial sectors' focus on sustainable and responsible investing.
The European Union (EU) example is especially instructive. One of the aims of the EU SFAP is to divert capital towards sustainable activities so as to reach the EU's energy and climate goals by 2030. These include increasing the share of renewables (sunlight, wind etc.) to at least 27% of final energy consumption and cutting greenhouse-gas emissions by a minimum of 40% compared to 1990 levels. This will require additional estimated funding of €180 billion per year. According to the European Investment Bank, that annual funding need rises to €270 billion, if all the goals for the energy, transport, water and waste sectors are included.
The EU framework, to be adopted before the end of next year, should help to ensure the integrity and trust of the sustainable-finance market through new standards and labels for sustainable-finance products such as green bonds . Known as the "sustainability taxonomy" in EU jargon, this unified classification system will hopefully help in measuring sustainable capital flows by codifying what can be classified as green or brown assets . In addition, it will cover activities contributing to climate-change mitigation and adaption as well as other environmental and social objectives. Having a unified classification system should also further foster the development of sustainability benchmarks and increase their transparency.
The European Commission is also taking legislative action to clarify investor duties in relation to sustainability and other ESG issues. In particular, the EU will provide explicit guidance in areas such as investment strategy, risk management, asset allocation, governance and stewardship. For example, institutional investors and asset managers will be required to disclose how they consider ESG factors and climate-change-related risks in their investment process. Asset managers will also be required to proactively ask their clients about their sustainability priorities and explain how sustainability considerations are incorporated into their investment products.
All this hints at the contours of what sustainable finance will look like. The European example provides an idea of just how wide-ranging the implications are. And, as mentioned above, Europe is hardly alone.
Take the efforts to green the financial system adopted by the appropriately named Network for Greening the Financial System. This group is comprised of representatives of central banks and financial-market supervisors from both developed and emerging-market countries. Already, it is pushing for increased corporate disclosure specifically in the area of climate-related risks. Disclosure not only has benefits for market transparency, but can also yield important insights for supervisory oversight, regulation and policy-making.
What does it all mean? Well, we are witnessing a coalition of actors across the developing and industrialized world that are taking steps to classify, assess and, in certain geographies, legislate to re-orientate capital flows towards sustainable investments. Their goals of managing the financial risks stemming from climate change and fostering transparency and long-termism appear praiseworthy. While there are questions of how all of these developments will work in practice, we believe investors need to be involved in shaping and preparing to implement these new expectations. At DWS, we continue to deepen the integration of material ESG factors and strengthen the role of sustainability within our investment-decision-making process. For those of us working in the asset-management industry, these are exciting times.
Source: European Commission (March 2018). European Commission Action Plan
1. Green financing: Any financial instrument or investment that seeks to create positive environmental benefits and a return for investors or lenders.
2. Green bonds: Any type of bond instruments where the proceeds will be exclusively applied to finance or re-finance, in part or in full, new or existing eligible Green Projects. Examples of such projects would include areas such as pollution prevention and control, as well as renewable energy and energy efficiency.
3. Green / brown assets: This term is linked to an EU policy proposal where green loans or investments such as for renewable energy or energy efficiency could receive a lower capital requirements ("green assets"). By contrast loans/investments linked to polluting activities such as coal would receive higher capital requirements (brown assets).