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ESG investing – Policymakers are struggling to keep up with growing demand

By Ding Li, Senior Strategy Consultant at Longevity Partner

Reuters recently published a report highlighting the critical issues around ESG investment funds, castigating the superficial and ineffective nature of the EU’s Sustainable Finance Disclosure Regulation (SFDR). Regulations should be standardised, objective and mandatory. This, combined with the allocation of public resources towards enforcement, is what is necessary for ESG investing to have a positive environmental impact.

ESG investing is booming. The sustainable mutual fund market is at an all-time high and shows no signs of slowing with ESG funds accounting for 90 per cent of July’s equity fund inflows. Added to this, most IFAs rank ESG as extremely important.

But, with the lack of regulatory clarity and enforcement procedures, it is no surprise that some fund managers are deceptively labelling their investments to classify their funds as ESG-compliant, resulting in a greenwashing effect occurring within the investment industry.

The issue is subjectivity. The SFDR categorised all funds as Article 6 when it was introduced in March this year. The onus has been put on fund managers to label and upgrade their own funds from Article 6 to Articles 8 or 9, with the higher the ranking, the better ESG standard. There are obvious short-term incentives for some managers to be generous with what they class as ESG. The problem with this approach is that more stringent regulations which provide clarity will come, as will a penal system, resulting in an abundance of such funds no longer being appropriately labelled and possibly being penalised.

The EU plans to update its taxonomy and will require funds to disclose how they comply with the EU’s Regulatory Technical Standards from July 2022. Being slow to the mark to implement genuine ESG funds will likely have a negative impact in the future and funds could find themselves the subject of scrutiny by activists, the media, and increasingly emboldened regulators.

Materiality

At present, managers wanting to take a strategic approach to transform their fund’s ESG credentials can employ a materiality analysis; a methodology which Longevity Partners uses to assist clients.

Materiality is a method of identifying and prioritising the most important issues facing an organisation and its stakeholders. It can help funds spot associated risks and allows companies to devise a bespoke ESG strategy with specific goals. This holistic approach will ensure the ESG strategy is impactful and long-lasting. From this, funds can confidently and authentically report their data to their stakeholders.

Materiality isn’t a solution to greenwashing per se, but it is an effective strategy for funds that want to gain an edge and pre-empt regulatory changes. Only funds that want to make impactful changes will employ an objective third-party to conduct an analysis. It’s these funds which will create a positive long-term impact and will avoid scrutiny once standardisation and disclosure comes into effect in the near future.

What is next for green financing regulation?

Policy makers in Europe are struggling to keep up with the ESG gold rush. A uniform regulatory environment where more resources are funnelled towards effective enforcement will create an investment landscape where investors can trust that their money is being invested responsibly.

Just because a fund can be classified as ESG under the current landscape, it does not mean that it should be classified as ESG. Taking advantage of the current lack of standardised regulation might create short term gains but will ultimately result in long term negative impact for both the fund and the environment. Funds and businesses that realise this, act now, and pre-empt regulatory changes, will gain a significant environmental, financial, and reputational advantage.

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