The EU’s new regulatory framework for Environmental, Social and Governance (ESG) investing has caused confusion among the fixed income market, but is putting more pressure on new funds to add an ESG label to their credentials.
That was the word from an ESG panel looking at the inroads made by sustainable into mainstream portfolios, and the potential risk management and resilience benefits they may bring.
The EU’s Sustainable Finance Disclosure Regulation (SFDR), the first stage of which was introduced in March 2021 set rules for banks and asset managers to provide information about investments’ ESG risk credentials for the first time.
However, level two of the regulation, focused on technical disclosures, including a taxonomy for labelling funds, has been delayed until 2023.
The SFDR’s taxonomy includes progressively greener categories: ‘Articles 6, 8 and 9’. Corporate bonds are addressed by the regulation, but sovereign bonds remain outside the fence.
The greenest funds are labelled “Article 9”, while to be labelled ‘Article 8’ a fund must “promote” ESG characteristics.
“To be an ESG fund you have to be minimum Article 8,” said Imane Kabbaj, sustainable investment specialist, PineBridge Investments. “When SFDR first came into place, Article 8 and Article 9 funds represented around 25% of the funds universe, but that number increased to roughly 50% by Summer 2022.”
Under the protocols of the EU’s Mifid II regulation, investment firms are required to ask clients about sustainability criteria for their investments, noted Kipp Cummins, head of EMEA fixed income, Dimensional.
All of this is “setting the bar higher”, he suggested, putting the onus on new funds to market themselves with ESG credentials.
“Given a choice to launch a new fund with a sustainability label or not, you’d have to be crazy not to go with ‘Article 8’,” Cummins said.
“However, you’ve got to be careful not to make claims about ‘Article 9’ that you can’t substantiate,” he added.
Which investments can be classed under ‘Article 9’ remains a concern for Europe’s investment firms, panellists agreed.
“As a firm, we’ve taken a severe approach so far as to what we can call ‘Article 9’,” said Giulia Pellegrini, deputy CIO, emerging markets fixed Income, portfolio management and ESG, Allianz Global Investors.
“Green bonds are the best way, we think, verging towards the ‘impact investing’ concept. Green bonds are at a stage of principles, practice and transparency of data that are consistent with the ‘Article 9’ label for our funds,” she said.
Transparency is vital to “avoid getting caught up in greenwashing claims”, she emphasised, noting that Allianz uses criteria from a range of independent bodies, including the World Bank.
“On top of having to abide by [SFDR] principles we have our own requirements, so we always overlay our own assessment process even when they are given an ‘Article 9’ label,” Pellegrini said.
Data have improved for sustainability linked bonds, but “they’re not there yet”, she suggested, but the increased debate on which investments could be included was healthy, she added.
Definitions for ESG investment can differ depending on what investors are trying to achieve, panellists pointed out, whether it is viewed as risk management with portfolio resilience in mind, or an ethics- and values-based approach – so-called ‘impact investing’.
Asset managers “have taken a step back,” he said, from promising an ESG approach would bring about stronger returns.
“It’s important to take a step back and avoid spurious claims. You have to be clear about how you’re going to achieve your goals and what data backs it up,” he said.
Recent extreme weather events across Europe and North America have highlighted the interplay between climate change and macro-economic risks.
“There is a growing body of research that shows the materiality of these risks, and having mature risk frameworks makes these entities better positioned for the long-run,” said
However, specific data linkages between macro-level global warming risks and investor returns at a company, fund and portfolio level are still hard to come by.
“The risks are real. We’ve all seen the recent floods in Germany, for example,” said Cummins. “But it’s still difficult to make the claim that sustainable investment will lower the risk portfolio and drive up returns,” he added.
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