AFME May 2023: Key Takeaways

Following our attendance at the AFME European Sustainable Finance Conference, we reflect on our key takeaways in relation to regulation,  implementation, and more.

What are the current ESG investment considerations?

Some of the panellists found that Asian sustainable products and biodiversity/nature-driven investments were likely to be a top priority together with geographically specialised investments based on the acceptance of regional differences and different perspectives.

Others noted that “Decarbonisation/net-zero” portfolios are difficult to achieve without having significant performance impact, but that stewardship is key to marry such transition strategies with performance.

The advice was for asset managers to manage for risk & return as well as impact, whilst considering that trade-offs can be at risk, return or impact level and when selecting data providers, one must clearly identify what the objective is and align the due diligence questions and collection with such objective.

In order to achieve net-zero strategies, asset managers should look at use of proceeds for Paris-Alignment of investments /commitment to be net-zero by 2050 and put in place a clear plan and milestones (e.g.  five years to prove to be on target). The recommendation was also to align with SBTi to clearly identify the impact.

From a risk management perspective and particularly with regards to “Climate risks”, the recommendations were to be granular, to capture specific risks and to consider sector specific risks.

Overall though, all agreed that more education was needed on the sustainable finance / ESG topic.

How can regulation work?

The audience and panellists felt that the pace of regulation is an issue, in that it creates uncertainty, is too fast paced and does not allow for things to be thought through.

In addition, discrepancies in the various regulatory regimes are bringing added challenges to reporting obligations.  In this regard, participants noted that the ESRS framework, which is aligned with the ISSB, should help reduce the regulatory burden and that the international organisations are currently working on interoperability between GRI and EFRAG.

A brief note about the Corporate Sustainability Reporting Directive (“CSRD”):

Corporate sustainability due diligence must be principle based and enhanced by sector focused rules. In addition, what is key, is linking managers targets to environmental objectives to have a real world impact. The speaker noted that to drive a behavioural change only using sticks will not work, and carrots will be needed too. Incentives will need to be created.

CSRD should also provide key information when consider Macros that can have a significant impact on supply chain and operations and as such is key in driving change.

Defining “Transition Finance”:

“Giving anyone the opportunity to get better at what they are doing.”

Financing the transition means enabling the scaling up of climate solutions. The whole economy must transition either 1) away from fossil fuel dependencies; and/or 2) towards renewable energies, whilst at the same time considering the social costs of transitioning.

One person denoted that using the term “transition finance” can lead to confusion as there is no clear definition/guidance, nor clear KPIs to measure transition and therefore a framework is needed.

Regulation should be enhanced by clarification on how the existing framework can support transition activities (eligible for CapEx disclosures, such as R&D eligible activities): e.g. if company has a plan to exit “significant harm” it is causing addressing topics such as adaptation and behavioural measures being taken. In this regard, further FAQs to be published around the EU Taxonomy Regulation, which is black and white and science based, should provide such clarification.

Whilst the Corporate Sustainability Reporting Directive is key in this context, the Net-Zero Industry Act (supports manufacturing of new technologies via investments) should also helps, but alone it is not likely to be sufficient to support the transition. As such, companies should be working together around sequencing of materials re-use and considering energy investment ratios (to be 4:1 now, 7:1 in next decade and 11:1 after that).

Other considerations were the problem with analysing emerging markets as these are starting from different economic standards, so certain models may not be appropriate and cannot be applied.

For the EU region, the EU Taxonomy includes relevant CapEx considerations that should be taken into account.

In addition, the Green Gateway Platform will help SMEs who need the transition plan (see framework for real economies and SMEs).

Again, the point was made that more education is needed as to what it means.

The spotlight is on Biodiversity

“The world of nature is the great infrastructure that keeps our world safe: 69% of ALL world animal population is gone and declined (the workers running the factory are gone!): we are financing ourselves to extinction.”

As the next big priority for investment firms and all financial actors alike, biodiversity, as thematic-opportunity, took to the centre stage. Businesses will need to understand the dependencies on connectors for biological diversity in terms of: impacts, risks and opportunities (e.g. alternative meats, farming), ascertained within its specific geographical location and in the context of nature, businesses should also assess scope 1: direct impact; scope 3: upstream (sourcing), downstream (distribution), financed (banks).

The Task-Force on Nature-Related Financial Disclosures (TNFD framework) provides a disclosure framework and sector guidance based on Science Based Network standards (SBTN standards) in order to carry out forward-looking scenario testing.

TNFD includes 3000 metrics split into: core global, core sectoral, additional (all scientific based) and is flexible to accommodate other reporting frameworks as based on SASB.

The world needs a reform of our food system through re-generative agriculture, and this only one of the opportunities available in this space. The size of the biodiversity related opportunities is the financing gap of $7bn.

Future regulatory outlook notes:

EU-level comments:

Representatives recommended participants to “just start” (even if an imperfect plan) and noted that the regulator is looking at who is taking this seriously and who is looking at ensuring longevity of operations. Regulators are focused on tackling Greenwashing risks and they look to issue reports which will identify what greenwashing is, with a final report in 12 months. Such reports are tools given to the market to discern good/bad practices and to encourage more supervisory convergence. Different supervisory interpretations from different EU regulators are due to concepts not being clarified enough, and there not being enough guidance. At the same time, the EU authorities intended to leave room for innovation.

On this note, ESMA noted that it intends to improve and increase the education of staff and that it is looking to correct the agenda as much and as little as necessary; and whilst the disclosure regime is not quite working as expected, more will need to be done on investor protection to provide clearer and more accessible information. In this regard, ESMA is looking to transform SFDR to a minimum criteria regulation (not to become a label regulation) and to provide rules to address fund naming.

On a more specific note, ESMA noted that “Just and inclusive society” objectives will be included in the Social Principal Adverse Indicators and that the recent clarification on “sustainable investment” included in the latest FAQ means that both economic activity level and company level can be used as a means of assessment.

UK views:

The FCA noted that the UK SDR rules are still being finalised and expected to come in Q3 this year but that there should be no surprises. The FCA will ensure that everyone has time to implement, except for “greenwashing rule” which will be effective immediately, in alignment with EU and other global standards.

Irish perspective:

A CBI representative mentioned that more emphasis on supervisory rules is coming and that the issues raised by ESMA will result in scrutiny/supervisory rules from regulators. However, regulators are also looking to help industry in clarifying what the expectations are. It is likely that regulators might use natural language processing technology to identify compliance going forward.

In relation to the revisions of SFDR, it was clarified that the amount of needed to be reviewed to simplify the templates and that “labelling” will need to be part of the conversation around SFDR, despite it being not labelling regime.