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How to assess whether or not an investor or a fund is truly sustainable

Module 4. How to assess whether or not an investor or a fund is truly sustainable - 20min

An important question for investors

You may be wondering how you can ensure that the product in which you want to invest is “sustainable”? This is a very important question for investors.

With investor appetite and flows to sustainable investment rising rapidly, there’s a growing incentive to market one’s investment approach and products as sustainable. This triggers the risk of greenwashing.

Greenwashing is the process of conveying false impression or providing misleading information about how sustainable a company’s products are. Greenwashing is considered an unsubstantiated claim to deceive consumers into believing that a company’s products are environmentally friendly.

Imagine you went into a supermarket to choose a new laundry detergent. You are attracted by the branding of this product that uses a green design, a product name referring to forests (“forest fern”), and claims to be an “eco-wash.” But all this is vague. You should see whether the company provides any evidence to justify this sustainability branding.

You have done some research that has led you to understand the following:

  • There is no label or certification to assess the “eco-wash” claim.
  • The brand refers to “forest,” but it is not recognized for its sustainability commitment by any third party.
  • This product contains petrochemicals components that are harmful to the environment.

This laundry detergent’s “eco” branding is then misleading you as a consumer. The fact that this product is implicitly branded as sustainable can influence consumers who are increasingly attracted by sustainability claims.

Branding this product as sustainable is considered an unsubstantiated claim to deceive consumers into believing that the product is environmentally friendly. This is an example of greenwashing.

Considering the example of the detergent bottle, the following section illustrates that the same considerations are true for investment products

Consider these three things:

  1. the label or third-party certification of the product (e.g., an SRI label),
  2. the sustainability commitment of the brand (e.g., a commitment to PRI), and
  3. the underlying instruments of the portfolio (e.g., just like the laundry detergent, some of them may be harmful).

Understanding regulation 

Regulators across the globe are setting up an increasing number of regulations linked to sustainable investments. 

These regulations can be linked to the following: 

  • Activity mapping: indicating which activities are sustainable or not, sometimes referred to as taxonomy 
  • Disclosure: encouraging companies or investors to disclose information on their management of E, S, and G issues 
  • Fund categorization: encouraging clear fund categorization based on sustainability objectives 

 

 

Regulation in Europe

The European Union has established a Sustainable Finance Strategy, which is part of the EU Green Deal, an action plan including a roadmap with concrete actions to ensure net emissions of greenhouse gases are at zero by 2050.

As part of this European Green Deal, the EU Sustainable Finance Strategy supports three overarching goals:

  • Reorient capital flows towards sustainable investment
  • Mainstream sustainability into risk management
  • Foster transparency and long termism

The Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy Regulation (EUT) are cornerstones of this Sustainable Finance Strategy with other sets of standards and regulations. The regulations are broad in scope and stringent in their requirements.

  • Sustainable Finance Disclosure Regulation (SFDR): This Regulation lays down harmonized rules for financial market participants and financial advisers on transparency with regard to the integration of sustainability risks and the consideration of adverse sustainability impacts in their processes and the provision of sustainability‐related information with respect to financial products.
  • EU Taxonomy Regulation (EUT): The EUT is a standardized classification system designed to help users determine what is environmentally sustainable. To achieve this, the Taxonomy specifies a common set of criteria that must be met to determine if an activity is environmentally sustainable.
  • Green Bond Standard (GBS): Any green bonds issued under the designation “European Green Bond” need to comply with the GBS, for example, by classifying the economic activities financed by the bond in accordance with the EU Taxonomy
  • Corporate sustainability reporting directive (CS): RDThis directive aims to improve sustainability reporting by listed and other large European companies, including whether companies’ activities make a substantial contribution to any of the environmental objectives listed under the Taxonomy Regulation.

Investigating an asset manager’s sustainability commitment: useful external assessments

To evaluate an asset manager, you can first check the policies and disclosures on its website. Then you should consult external assessments to obtain a third-party evaluation, which often is more neutral, and an independent screening of those policies.

An increasing number of external assessments can help investors assess asset managers’ sustainability practices. This information will help you identify the leaders and the laggards, best practices, and areas for improvement.

Using the PRI transparency report and assessment

PRI signatories are required to report publicly on their responsible investment activities each year. This reporting follows the industry standard. The PRI Transparency Report and Assessment can help you review and compare the asset manager’s report.

Because individual sustainability reports do not necessarily follow the same structure, PRI Transparency Reports can help you compare the responsible investment practices of different investors on each of the PRI questions. The PRI intends to help signatories identify how they can improve their responsible investment practices and facilitates learning and development, outlining how signatories’ implementation of responsible investment compares year-on-year, across asset classes, and with peers at the local and global level by providing a confidential report. The PRI assessment aims to allow asset owners to focus their discussions with investment managers on responsible investment activities and capabilities in cases where the managers’ assessment has been shared with them.

Sustainable funds: the SFDR classification

Understanding Labels – A label is a tool to ensure that investment products meet a certain number of sustainability criteria.

To compare everyday products, the organic label on food products lets consumers know that it actually has been certified “organic.” For investment funds,

a product with the SRI label or the Greenfin or Finansol label, as well as other similar other labels, guarantees that it is substantiated by a verified sustainable process.

Labels exist to guarantee: the quality of sustainable financial management for the general public, an ESG methodology and engagement process, and transparency.

Labels can be used to verify the incorporation of ESG into the securities that are included in the portfolio: But are these labels binding or not (e.g., the French SRI label or the Belgian label called Towards Sustainability)? Labels can also be used to reward products that have committed to meeting a real objective of investing in green or social activities (e.g., the Greenfin label).

Contrary to fund labels, fund ratings usually look at a fund’s underlying instruments and do not rate the ESG incorporation process or the sustainable investment strategy used. Ratings provide information on the outcome of this process, but they do not necessarily consider the objectives of the fund, which could include generating an environmental or social impact.

It is interesting to look at the different approaches to rating as well as at the rating methodology to ensure that it is aligned with investors’ objectives.

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To which type of regulation does this policy belong: “The Hong Kong Stock Exchange set up ESG reporting requirements in 2015 for all listed companies.

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What are the similarities between SFDR classification and labels?

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