Sustainable Finance Challenges and Opportunities

This blog post is based on the intervention of Rodrigo Tavares in the webinar on Corporate Due Diligence and Sustainable Finance organised by the Nova Centre on Business, Human Rights and the Environment with the support of the Portuguese Presidency of the Council of the European Union in partnership with the British Institute of International and Comparative Law, the Portuguese Ombudsman (Provedor de Justiça), the Teaching Business and Human Rights Forum, and NOVA 4 The Globe on the 27th of May 2021.

 

About the author: Rodrigo Tavares is founder and president of the Granito Group, a company that advances the sustainable economy through strategic consulting, financial advisory services and policy & research. Rodrigo is also a professor of Sustainable Finance at NOVA School of Business and Economics.

 

Question: What are the implications of the rise of sustainable finance for financial actors. Is sustainable finance profitable?

There’s a lot of questioning around the probability of sustainable finance and, actually, there is no ‘yes’ or ‘no’ answer for this. Just like I will not be able to say whether private equity or venture capital is profitable because it totally depends. It depends on geography, depends on asset classes, depends on investment styles, depends on timeframes, depends on whether you are investing in companies at the very beginning or at the plateau of their ESG journey. So, it depends. But I would like to say two things. Just this year there was a new meta study from New York University and Rockefeller Asset Management, which aggregated findings from more than a thousand research papers authored between 2015 and 2020. And this meta study concluded that 59% of these individual studies showed that ESG-related investments have similar or better performance relative to conventional investment approaches. Another illustration that I could make derives from comparing ESG indices with non-ESG indices. And I’m actually just looking at them right now. So, if we compare baskets of stocks with high pedigree on ESG relative to baskets of stocks with no ESG credentials we are going to realise that, in most situations, the performance of indices which bring together ESG companies is superior. A very quick example: if I compare MSCI Europe with the comparable ESG index in Europe, in three years, the performance is 3.48% higher and risk exposure is also much lower.

 

In academia there is an inclination to believe that there are strong correlations between ESG and financial performance, but we still need more research.



Question: what do you see as some of the main challenges or threats, right now, in terms of sustainable finance?

 

There are a few worth mentioning. 

 

The first one is data. The data issue comes up over and over again. There’s a reason why data is problematic within the frame of sustainable finance. There are more than 30 sustainability disclosure frameworks. As a comparison, if a company wants to report its financial data, there are only two disclosure frameworks: GAAP in the US, and IFRS in the rest of the world. But if a company wishes to disclose sustainability data, there are more than 30 different frameworks. At the same time, there are around 100 ESG rating agencies. Again, if we compare these with credit risk agencies, there are only three major ones. This leads to inconsistencies in data collection, data analyses and data reporting. So, data is a problem.

 

Problem number 2 is related to materiality. We all know that not all ESG issues matter equally. The relevance of ESG issues varies according to industry, country, company, etc. And ESG asset managers still lack robust skills to identify the most material ESG indicators.

 

The third challenge could be lack of products. Public markets are fairly well covered in terms of product offering, but options are still lacking for high yield and IG fixed income products. And options are still lacking in the alternative space. There are not a lot of ESG hedge funds, for example. Most of them are still not ESG. Sustainable investments would also benefit from the development of a fully-fledged derivatives market, which does not exist yet. So, it’s not necessarily true that there is a wide range of impeccable, impressive, high quality ESG products in all geographies in all asset classes exposed to all sorts of risks. That is not necessarily reasonable to say.

 

The fourth challenge is probably the most problematic one. It’s the whole issue of greenwashing. Unfortunately it is not uncommon for asset managers to rebrand funds for fundraising or for marketing purposes. Greenwashing might be involuntary, too. Sometimes it’s not driven, sometimes it’s involuntary. And this results from the fact that there is no global standard yet for responsible or sustainable investment funds. Funds can call themselves whatever they wish. If I’m a fund manager, I can just raise my hand and say that my fund is an ESG fund. There are very few guidelines on that. So greenwashing is problematic. Actually, there is a 2020 a study by the Two Degrees Investment Initiative, which found out that 85% of thematic funds, specifically sustainability-themed funds, have misleading marketing. Probably in 10 years we will not be talking about sustainable finance because it’s going to be fully embedded into risk assessment strategies, profit seeking strategies. But while we are still talking about sustainable finance, I think we have to be cautious and refrain from being over optimistic. We need to look at reality with some critical thinking.  There are still some challenges in the sustainable finance field that we still need to overcome.



Question: How to incentivise improved data, for example, disclosure by companies. Can you share some insights with regard to any developments in this area, whether it’s in relation to the British Standards Institute/ISO initiative?

 

On the British Standard, a little bit of context. In the sustainable finance field, we have moved away from an initial phase, about a decade ago or so, when there were virtually no guidelines or schemes on financial sustainability practices, to a phase, the present one, where there are too many of those guidelines. There is a myriad of standards, principles, disclosure frameworks, taxonomies, guidelines, codes, etc.. So, there is a need to streamline, to merge, to find synergies between the different guidelines. And there is a need to find a global and prescriptive standard for investment funds.

 

Recently, the British government, together with the British Standards Institution (BSI) and in partnership with a very large number of financial houses, have recently joined forces to tackle greenwashing by developing the first classification system for responsible and sustainable investment funds.

 

It is important to mention that this new standard, coming from the ISO family, is prescriptive and rules-based. It’s not principle-based only. And the basic difference is that the new standard establishes minimum provisions that shall be complied with. It prescribes features a fund must have in order to comply with a responsible or sustainable investment system. So, in other words, the standard establishes the prerequisites that fund managers globally need to fulfil to be able to call their funds either “responsible investment funds” or “sustainable investment funds”. And, once the standard is out there, it will provide reassurance to institutional and retail investors regarding the funds in which they are investing. Let me underline that the new standard covers all asset classes – private equity, venture capital, equities, fixed income, real estate infrastructure, hedge funds, etc. It also covers passive and active strategies. And it covers both responsible and sustainable investment practices.

 

The process to launch a new global standard is very ritualistic, it’s very formal and it’s a collective exercise. Many players are involved. As the Technical Author of the standard I have submitted the first drafts and it is now in the process of being reviewed by a steering committee and later on it will also be subject to public consultation. We expect to launch it in early 2022. When the ISO family launches the standard, then the financial services community will finally have available a tool to guide them on whether investment funds are responsible, sustainable or whether funds are not related to ESG at all. I believe the sustainable finance markets needs this clarity and transparency to accelerate its expansion towards the mainstream.

Suggested citation: R. Tavares, ‘Sustainable Finance Challenges and Opportunities’, Nova Centre on Business, Human Rights and the Environment Blog, 5th July 2021.