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Sustainable finance is taking off. The pandemic is making investors, both institutional and retail, increasingly aware of it, while modifying their behaviour. Along with financial criteria, an investment is unthinkable without taking extra-financial aspects into account. Environmental, social and governance (ESG) challenges are all factors that bring new meaning to the performance of a financial investment.
Yes, but to what end? To finance not only the current transition towards a decarbonated economy and towards the energy transition, but also to help bring about a fairer society that allows everyone to meet their needs in a world of limited resources.
Meanwhile, sustainable finance is being fostered by an unprecedented wave of regulations at both the national and European levels. One such milestone was the SFDR regulation (known informally as “Disclosure”), which entered into force on 10 March. SFDR comes with a “taxonomy” that aims to establish a common, more readable language in order to steer investors towards those companies that are the most committed to a responsible approach from all points of view. Finance is indeed an essential tool in successfully transitioning our economies.
Our political leaders have understood this well. This ambitious regulatory convergence is therefore welcome and is all the more praiseworthy as it emanates from the level of the European Union.
For almost 25 years, we have been committed to sustainable finance and to the values of the social economy and mutual assistance that are the hallmark of the OFI Group. With this in mind, the regulatory focus on transparency assists investment management firms that are sincerely committed by giving them the option of calling attention to the more tangible aspects of their commitments. It also motivates our teams even more to do their utmost to provide our clients with an offering of higher-quality products and services, along with practices that are constantly being enhanced to accompany the transition towards a new, more virtuous model that reflects the interests of future generations.
Commitments enshrined in the Paris Agreement of 2015 have pushed European leaders into proactive measures to steer investment flows towards a sustainable and responsible economy. Heavy investment will be needed to bring about an economy that is truly decarbonated.
The Sustainable Finance Disclosure Regulation (SFDR), informally known as “Disclosure”, comes amidst a climate emergency, one that has pushed the European Union in recent years to establish a demanding and ambitious regulatory framework to foster financing that serves sustainable development. A climate emergency? In accordance with commitments enshrined in the Paris Agreement of 2015, the European Union is pursuing the goal of carbon neutrality by 2050. This was reiterated in the “Green Pact” submitted by the European Commission in December 2019.
To meet this objective, an estimated 200 billion euros will be needed annually just in Europe. The financial sector’s mission therefore consists of steering Europeans’ savings as profitably and efficiently as possible into companies that help meet these goals and construct a truly decarbonated economy.
FINANCING A DECARBONATED ECONOMY
For several years, European regulation in responsible finance has sought to encourage and to converge good practices at the scale of the continent. In May 2018, the European Union announced the implementation of an action plan in green finance and assigned it three main objectives:
In this context, the Disclosure regulation, combined with the Taxonomy* and Benchmark** regulations, is providing a regulatory framework steering European investors and citizens towards financial products that truly promote sustainable activities.
* Taxonomy regulation (Regulation (EU) 2020/852 of 18 June 2020 on establishing a framework for promoting investments durables). The European Taxonomy regulation establishes a common benchmark for activities that contribute significantly to mitigating climate change. It sets the thresholds for determining precisely an economic activity’s degree of “greenness”, thus allowing it to be classified as “sustainable”, based on various objectives linked to the climate, the circular economy, pollution and biodiversity.
** Benchmark regulation (Regulation 2019/2089 of 27 November 2019 amending Regulation (EU) 2016/1011). The Benchmark regulation introduces minimum transparency requirements in taking ESG criteria into account for index providers and lays down a framework for setting up two environmental performance indices: the “Climate Transition” and the “Paris Agreement” indices.
IN FRANCE, THE PACTE LAW ENCOURAGES RESPONSIBLE INVESTMENT
These EU-scale texts that have already been adopted or are in draft form bolster French legislation, which had already got a headstart in responsible finance with the introduction of Article 173 of the French Energy Transition Law (LTE) of August 20. LTE requires transparency from institutional investors in demonstrating ESG criteria in their investment processes.
In France, the PACTE law also encourages savers who hold a life insurance contract to invest “sustainably”. Since 1 January 2020, insurance companies have been required to provide at least one officially SRI-certified unit-linked contract to their clients for each contract offered. Beginning 2022, such contracts must offer at least one SRI fund, one Greenfin-certified green fund, and a Finansolcertified solidarity finance fund.
Driven by national and EU regulation, responsible finance is being built up gradually and is drawing growing interest from savers. This is why several certifications have emerged in recent years, from public and private bodies that recognise traditional mutual funds or solidarity savings.
The certifications help call attention to good practices. Here are some of them:
The French government “ISR” certification
Introduced in 2016 on the initiative of the French Ministry of the Economy and Finances, the ISR (SRI) certification is awarded to funds that integrate environmental, social and governance (ESG) into their investments. Since October 2020, SCPI and OPCI real-estate funds have been eligible.
Created in 2015 by the French Ministry of the Environmental Transition, the Greenfin certification guarantees a fund’s “greenness”. Nuclear energy and fossil fuels are ineligible for Greenfin certification.
Established in 1997, the independent body Finansol recognises solidarity savings products when the fund invests some of its assets in solidaritybased companies or foundations.
Created in 2015, the FNG label is the SRI-quality standard for sustainable investment funds in German-speaking countries. The FNG methodology includes transparency criteria and takes human rights, environmental protection and corruption issues into account.
DISCLOSURE: TIME FOR TRANSPARENCY
Approved by the European Union on 27 November 2019, SFDR is being rolled out in several stages, the first of which came into force on 10 March. SFDR will cover all financial market actors (financial advisors, life insurers, pension funds, investment management firms, mutual funds, etc.) in the European Union. It requires greater transparency from fund managers and distributors regarding the extra-financial criteria of products offered to savers.
For example, a distinction will be made between financial products that promote ESG aspects (classified as “Article 8”) and those that state an objective of contributing positively to the environment and/ or society (classified as “Article 9”).
A distinction is made between these products, classified as “Article 8” and “Article 9”, from other financial products considered to be non-ESG (classified as “Article 6”).
DETERMINING WHICH ECONOMIC ACTIVITIES CONTRIBUTE TO SUSTAINABLE DEVELOPMENT
It remains to be seen which economic activities address sustainable investment objectives.
The focus will be on integrating environmental, social and governance criteria in the company’s activities and its operational practices. Regarding environmental challenges, several key indicators have been developed in order to determine how much a company contributes to mitigating climate regulation, manages to develop products and services for preventing and controlling pollution, and promotes recycling, the emergence of a circular economy or the protection of ecosystems.
Meanwhile, companies that display ambitious social objectives are also sought out they can demonstrate that they contribute to combating inequalities, promote social cohesion and assist economic and socially underprivileged communities.
Lastly, the “G” of ESG has not been overlooked. Compliance with good governance is a prerequisite to any sustainable investment policy.
Does Disclosure’s entry into effect mean the coming of age of responsible finance in Europe?
Alain Pitous: Yes, it does. Let’s say that it makes it possible to move up to the next level, with the aim of onboarding all actors in the financial community, including banks, insurance companies, investment management firms, wealth advisors, companies, savers, and so on, all at the service of the same objective.
Through this regulation, which is part of a comprehensive plan, the European Union is rolling out an ambitious policy to do its utmost to comply with the commitments it made under the Paris Agreement to cap the increase in temperatures at 1.5°C and to achieve carbon neutrality by 2050. We have no time to spare!
Guillaume Poli: Interestingly, various regulations (Basel 3, Solvency 2, MiFID 2 and others) that have been put through since the 2008 financial crisis have had the ultimate goals of securing the financial system and, hence, protecting savers. It took years to negotiate these complex and specific regulations for each type of actor. What is new with the Disclosure regulation and the taxonomy regulation is that this time the regulator is acting much faster and is determined to change finance to do nothing less than “change the world” and restructure our economies by steering investment flows towards a sustainable and responsible economy that addresses climate challenges.
Savings, investors, companies, as well as policymakers and consumers – ultimately, all of society is involved in shifting our ways of producing and consuming and forestalling climate risk. Finance then plays a decisive role in promoting and allowing this change.
The recovery plan gives us a unique opportunity to finance the energy transition
How can this regulation help companies modify their practices?
Guillaume Poli: The entire challenge of current regulation is to steer investor savings towards actors that protect the environment and society in general. A company that fails to comply with ESG criteria put itself in jeopardy in several ways, particularly the risk of lacking sources of financing sooner or later. The assumption that a little financial performance must be sacrificed to be a virtuous investor has been put to the lie.
Alain Pitous: This regulation can undeniably contribute to moving the goalposts in an unprecedented context. With this in mind, the 750 billion euro stimulus plan put forth to get the EU out of the pandemic-caused recession is a bonanza for responsible finance. The massive funds from the recovery plan is a unique opportunity to finance the energy transition, to provide massive support to green energies and to assist individuals amidst unprecedented change (through training, digitalisation, etc.). Europeans’ savings must be steered towards sustainable investments and help responsible companies develop. Even the ECB is now including sustainable finance as one of its criteria in its monthly purchases. The institution headed by Christine Lagarde has even just opened an expert centre dedicated to climate change.
But what should we be especially aware of with such an ambitious regulation?
Guillaume Poli: It is important to guide companies successfully in their transformation. Let’s face it: this is an exciting but tough challenge. We cannot simply cut off the financing of certain companies overnight on the grounds that their carbon balance is subpar, without generating other problems, social ones in particular. The challenge is therefore to organise the transition of the economy on the whole, without destabilizing companies but while accompanying them in making in-depth changes to their model. As far back as 2006, the Principles for Responsible Investment (PRI) urged financial actors to commit to a transition approach. A company that does not comply with these principles must have the opportunity to do so in order to take part in the sustainable economy that must emerge.
The Disclosure regulation (or SFDR) is helping to build sustainable finance on a European scale. It will be rolled out in several steps and will make it easier to compare financial products on sustainability, based on how much extra-financial criteria are included in the investment strategy.
Since 10 March 2021, all financial market actors (asset managers, insurance companies, banks, financial advisors, etc.) have been subject to a new European regulation, called the Sustainable Finance Disclosure regulation (SFDR). The regulation requires additional transparency regarding end-savers.
Financial professionals will now be required to state how they integrate the extra-financial criteria affecting sustainability:
In concrete terms, an investment management firm that distributes funds must provide explicit explanations on how sustainability risks are taken into account, i.e., any environmental, social or governance event that, were it to occur, could have a material negative impact on an investment’s value.
It is therefore necessary to explain how this risk is integrated in the management process, why such or such a security was selected based on such a criteria, and so on. This is not a statement of intent but, rather, a precise justification of the commitment of the investment management firm that oer the fund based on certain clearly stated criteria, including:
This regulation is expected to foster healthy competition between financial actors and an increase in good practices
January 2022: the time of standardisation and harmonisation
From January 2022, disclosure of extra-financial information will be harmonised. Investment management firms and financial advisors will be required to use a standard format, a datasheet that must include certain product characteristics. The datasheet will say whether the fund being offered to savers has a sustainable investment objective and whether it integrates ESG criteria into its selection of securities. Current fund prospectuses are more or less explicit on these subjects.
The harmonisation scheduled for January 2022 will make this clearer.
June 2023: a precise list of pointers will make it easier to compare funds with one another
This is the last stage of the SFDR regulatory rocket. In two years, the regulator will require a precise list of pointers from all financial actors over time, including the rate of greenhouse gas emissions (GES), the ratio of diversity on boards of directors, the portfolio’s “temperature”, etc.
It will then be easier to compare investments with one another. The data and figures divulged will provide a basis on which to judge a fund’s actual impact on the environment or on society. This will make it easier to compare investments with one another and make easier for savers to choose.
Harmonisation and standardisation of ESG disclosures should make it possible to distinguish between three categories of products:
This transparency effort required of financial actors in complying with ESG criteria is likely to generate healthy competition amongst them and promote a virtuous circle of good practices. In short, it won’t be possible to do responsible finance without wearing it on one’s sleeve. This will obviously help combat greenwashing.
To investors, retail investors in particular – what may seem complex at first glance is mainly the guarantee that they will possess useful information for investing their savings in an enlightened manner at the service of a more responsible and virtuous economy.
We are of two minds. On the one hand, efforts to regulate financial disclosures and prevent greenwashing by providing more transparent, standardised and harmonised information are praiseworthy in principle. We are even more in favour of them, as Mutavie and OFI AM are both convinced of the importance of savings managed on the basis of sustainable investment criteria, with long-standing know-how in this area and constant efforts to promote these vehicles in our life insurance offers.
On the other hand, this is yet more regulation that will come on top of already overblown precontractual disclosures. We therefore have some legitimate reservations on its true impact with end-savers, most of whom have neither the time nor the inclination to plough through all these documents.
Although it is up to the end-client to review, or not review, these additional data and to decide which funds to invest in, we do have a role to play, as well as an advisory duty. We work on selecting investment ideas and thematics to offer funds that will integrate the sustainability features that we prefer.
We believe that the Disclosure regulation will act as a point of convergence between financial actors. We are seeing more funds raising their sustainable development standards, as distributors and clients will be asking for the most committed funds, while more and more companies will seek to comply with sustainability criteria so they can be selected and invested in by fund portfolios.
The European “Sustainable Financial Disclosure regulation” (SFDR) came into force a few weeks ago. It classifies financial products into three new categories, based on how much investment management firms take extra-financial criteria into account in their investment choices and their methodology for doing so. A new classification is closely correlated to the ESG methodologies used.
The new European “Disclosure” classification, combined with the “Taxonomy” and “Benchmark” regulations, is the cornerstone of the European Commission’s action plan for sustainable finance initiated in 2018. Its purpose is to steer investor and citizen savings more into financing sustainable activities and companies that contribute to the energy transition. All with the clearly displayed ambition of financing the energy transition to achieve carbon neutrality by 2050.
Product classification into three categories
The Disclosure regulation imposes new obligations on financial actors in terms of transparency regarding the degree of sustainability of financial products distributed to savers.
As a result, investment management firms are now required to provide an entire series of disclosures on integrating sustainability risks and their potential negative impacts on asset values. They must also prove their investment choices’ contribution to an environmental or social objective.
On top of these transparency obligations, the challenge is being able to show investors and retail savers the ESG characteristics of various financial products distributed EU-wide in the most harmonious way possible. With this in mind and to help savers get their bearings amidst the plethora of funds calling themselves sustainable or responsible, the European regulator has introduced three new categories of products based on how they incorporate ESG characteristics or extra-financial objectives. All with a strong guideline: the greater a fund’s ESG focus, the higher the standard in providing clear and transparent information. Investment management firms will therefore be required to disclose data indicators or measurements of the “main negative effects” of investments in the areas of sustainability.
Effective 10 March 2021, investment funds have therefore been classified in three separate categories:
ESG research at the heart of the mechanism
In concrete terms, a fund classified as “Article 8” takes ESG criteria into account, including financial ones and, with this mind, excludes issues with low ESG ratings. Although virtuous, this investment strategy displays no precise intentionality or quantitative objectives. In revanche, the Disclosure regulation sets no threshold and imposes the exclusion of any particular sector for a fund to be eligible for this category. It will ultimately be up to each investment management firm to demonstrate, based on the ESG research methodologies selection processes used that they have indeed incorporated extra-financial criteria into their investment decisions so as to reflect sustainability risks and negative impacts that could have an impact on the value of portfolio assets.
Meanwhile funds classified as “Article 9” may be considered as the market’s “greenest” funds in that they have a precise sustainable investment objective. The therefore represent the best of responsible finance, as they focus on a precise ESG criterion. They are generally impact investing or thematic funds able to provide tracking indicators on measurable and quantifiable objectives. In other words, for a fund to be classified as “Article 9”, it must lay out its objectives in social or environmental terms.
A product that claims a social and environmental impact while setting quantified objectives and detailing how it intends to achieve them could be classified as “Article 9”.
The Disclosure regulation is a major step forward in calling attention to environmental, social/societal and governance objectives, as it will apply to all asset classes and all investment products that are, or will be, available on the market.
A new framework that supplements a range of regulations already in place
As virtuous as it may be, the Disclosure regulation also aims to set an overall framework requiring investment management firms to explain how sustainability risks are incorporated in their investment choices, to highlight any negative impacts of investments made, and to state how these same investment management firms take both these dimensions into account in their investment policies. The Disclosure regulation sets no absolute threshold. It requires no sector exclusion. However, some stricter or more standardised French regulations, such as the official SRI label, require a 20% exclusion from an investment universe on the basis of an extrafinancial research and to enhance a portfolios ESG rating vs. its benchmark universe. Position Player 2020-03 of the French Financial Markets Authority (AMF) sets a number of mandatory rules or thresholds.
The Disclosure regulation supplements an already abundant regulatory framework in France and elsewhere in Europe. With Article 173 of the French Energy Transition Law (LTE) of 2015, the official SRI label and AMF position papers, France already possess a wide range of standards and rules in sustainable and responsible investment. Financial actors therefore face an entire set of contradictory regulatory texts that while they may sometimes converge, each has its own salient points. The challenge for investment management firms will therefore be in plotting a course among these various regulations. Each investment management firm will have to be able to classify its various financial products on the basis of each of these regulations to be in line with the best standards so they can draw as much attention as possible to their integration of ESG criteria.
Lastly, while this regulation sets a new course and now constitutes an important yardstick for European investors, clearly it does not encompass all ESG approaches, which can take many forms. For example, sector exclusions – which are a form of ESG integration – do not necessarily allow an investment fund to be classified as “Article 8” or “Article 9”.
Although they do contain binding requirements in portfolio management, sector exclusions do not set a mandatory reduction threshold for the entire portfolio. The Disclosure regulation, however, requires exhaustive ESG coverage of the investment portfolio and not just in such or such sector of activity. So merely implementing sector exclusions are not enough to claim full extra-financial integration for a portfolio. Likewise, the engagement approach that OFI AM has taken for several years now does not align with the Disclosure regulation framework. And yet, this approach consists in analysing a company, in particular its practices and its environmental impact, in order to assist it in adopting the best ESG practices.
Deployed over several years, this engagement policy helps a company reduce its negative social or environmental impacts. Implemented alone, such an approach is no longer enough to allow a fund or financial product to be classified as “Article 8” or “Article 9”. This engagement policy must therefore be combined with another ESG approach to meet the requirements of the Disclosure regulation.
While it does not draw in all ESG approaches in effect at investment management firms, the Disclosure regulation constitutes a major step forward in developing sustainable finance in Europe and should make an even greater contribution to steering savings towards a more sustainable economy, in line with the commitments of the Paris Agreement. This regulation will also require that investment management firms, like what OFI AM has been doing for several years, work on the relevance and quality of data to create value around a fully successful extra-financial integration.
Our OFI Responsible Solutions (OFI RS) line of funds convers the main asset classes and geographical regions. It takes three responsible approaches, which may criss-cross and overlap:
In addition to SRI certifications, which are sought out on a voluntary basis, SFDR provides a systematic and complementary reading grid for investors and savers wishing to incorporate sustainable development challenges in a concrete way in their investment strategies. It provides investors with transparent and standardised information (including integration of risks and negative impacts in investment decisions) on the financial product. Classification into “Article 8” or “Article 9” thus attests to the product’s high ESG quality, while helping to bring out several avenues for integrating extra-financial criteria, including an ESG evaluation, setting of social and/or environmental objectives, and alignment with a carbon-footprint reduction objective.
We are currently conducting research, particularly in high yield bonds, other bonds and emerging equities to supplement our offering of products classified under SFDR categories 8 and 9 and to expand and enrich the OFI Responsible Solutions product line.
Our ambition to have 100% of our directly and actively managed AuM classified in one of the two categories and to assist our clients and partners in their eorts as responsible investors.