World leaders are setting new targets for a wide range of sustainability issues, from cutting net carbon emissions to zero by 2050 to preserving biodiversity and heading off the threat of widespread land degradation.
The range of promises can be bewildering. The European Parliament recently agreed €17.5bn in funding to help member states move away from fossil fuels, especially coal. US president Joe Biden is seeking cross-party support for multi-trillion-dollar green infrastructure plans. Further promises can be expected at the UN climate change conference in Glasgow in November.
The funding gap
Even so, the United Nations Environment Programme points out that public funding alone will never be enough. It says three-quarters of countries have climate adaptation plans, but financing – and therefore implementation – remains far short. Developing countries alone need $70bn a year, rising to as much as $500bn by 2050.
The World Economic Forum has come up with even more daunting numbers, saying that half the world’s GDP depends on nature. Failing to value and protect natural resources and ecosystems could cost $44trn of economic activity a year.
The financing gap represents a significant opportunity for private funding, including the EU asset management industry and particularly Luxembourg, its largest hub.
Europe is already a global leader in the sustainable fund industry, having started the shift toward socially responsible funds with basic exclusion filters for nuclear power, tobacco, armaments, pornography and other businesses shunned by some investors.
As understanding about the cost to society, biodiversity and the economy of climate change has improved, so sustainable asset management has upped its game. What are now widely relabelled as environmental, social impact and governance (ESG), green or sustainable funds today embrace almost every asset class, region and economic sector worldwide.
Changing fund market
According to the European Fund and Asset Management Association, investors are lapping up funds of every shade of green. EFAMA says ESG fund assets in Europe rose by 37.1% in 2020, with net sales rising from just €19.5bn in 2016 to €235bn four years later. By the end of 2020, ESG strategies represented 11% of all fund assets in Europe.
The shape and scope of sustainable investment is evolving rapidly. Although institutional investors still dominate, retail customers are increasing their exposure as ESG moves further into the mainstream. Equities dominate, even more than in the non-ESG fund universe, although multi-asset strategies are expanding fast.
Impact funds that are focused on specific environmental or social goals also tripled their assets between 2016 and 2020, with a majority focused on investments designed to reduce carbon emissions.
One-fifth of ESG funds are passive, more than in the non-ESG market. Index providers have been quick to expand the range of filtered, exclusionary, best-in-class and other benchmarks for investors to choose from.
The total number of ESG funds on the market is now close to 3,000, with completely new vehicles being launched and asset managers also converting existing funds to green investment processes.
Despite the additional work required to identify green companies and grade securities issues, the European Securities and Markets Authority and EFAMA have both found that sustainable funds are actually less expensive than the market as a whole.
The sustainable finance industry may be growing rapidly, but there are barriers to ensuring investment actions match their promises, with the risk of greenwashing a principal concern.
The issue of data is central. The sector is relatively new and companies’ sustainability data is often patchy or non-existent, while methodologies and impact assessments are opaque. Efforts are underway worldwide to oblige private as well as listed companies to report on their climate risks and impact, backed by the commitment of the G7 countries. Financial institutions are under increasing pressure from central banks and market regulators.
Legislation will progressively set out reporting standards and impose requirements. Currently, corporate climate disclosures are voluntary, although countries such as Switzerland plan to make it a regulatory requirement, and EU legislation is in the pipeline.
The impact of legislation
The EU’s future Corporate Sustainability Reporting Directive will substantially expand the scope and detail of reporting from the Non-Financial Reporting Directive, which took effect in 2018. It is set to make standards mandatory rather than voluntary and expand the number of companies to which the rules apply from around 11,000 to as many as 50,000.
Many countries are adopting a report-or-explain approach, under which companies must publish sustainability data or provide clear, evidence-based statements as to why they are not doing so. Global and regional accounting bodies are moving to standardise their approaches.