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Navigating the future of ESG: Challenges, opportunities, and the drive for global standardisation

3 min read time

Giovanni Terranova’s reflections on the evolution of ESG, sustainable investing, and the industry’s next steps.

During September and October, I had the pleasure of joining panels at the Markets Group’s 3rd Annual Private Wealth Italy Forum in Milan, and the Italy Institutional Forum in Rome. These forums discussed the growing influence of environmental, social, and governance (ESG) considerations on the global investment agenda. The discussions were thoughtful and centred on ESG growth drivers, concerns about greenwashing, and the ongoing debate on the relationship between returns and ESG.

Major macroeconomic drivers to ESG and sustainable investing

The integration of ESG (environmental, social, and governance) factors into investment practices has experienced considerable growth in recent years. Sustainable and impact investing have now become mainstream strategies in the investment landscape which I believe has been partly fuelled by macroeconomic drivers including:

1) Investor demand and requirements

2) Regulatory drivers (particularly in EU and UK)

Investor demand in a post-pandemic world

The COVID-19 pandemic has heightened investor demand for strategies that integrate ESG factors and create social impact due to the rise in prominence of socioeconomic issues. As climate-related events like floods, heatwaves, and storms become more frequent, they not only affecting our daily lives but also pose risks to the stability of investment portfolios – especially for physical investments such as infrastructure.

Regulatory drivers and their challenges

Governments globally are implementing net zero targets and roadmaps, with Europe leading the way in ESG regulation through the introduction of the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy while being ahead of the curve on topics around nature, biodiversity, ecosystems, clean water, and pollination, components that are supportive of sustainable infrastructure development.

The risk of greenwashing and Article 8 and 9 Fund Trends

Although the number of Article 8 and 9 funds has generally increased, about 350 funds downgraded from Article 9 to Article 8 at the end of 2022 with funds and managers wary of potential greenwashing allegations. This is partly due to regulatory ambiguity and the absence of past precedents, allowing managers to ‘self-certify’ and interpret the rules freely, which doesn’t provide much assurance for investors.

The EU’s response

Recently, the EU launched a consultation process to review Article 8 and 9 funds. Open until 15 December 2023, the consultation aims to establish a clear framework to improve transparency of fund labelling. The effort is intended to prevent greenwashing and creates an avenue for the regulator to bring in needed clarity and simplification.

Standardisation is required

In my opinion, a global standard for ESG regulation is essential, rather than the diverse frameworks currently in use across various jurisdictions like the EU, UK, and US. The rapid emergence of multiple standards can overwhelm both investment managers and investors, with additional risk of compromising the quality and potential value of ESG reporting. A unified approach would not only alleviate this fatigue but also enhance the integrity of reports; important for enabling clear benchmarking whilst satisfying the need for more rigorous auditing. Standardisation simplifies the comparison of funds by establishing a consistent framework of transparency and trust.

Avoiding greenwashing

Governance:

  • Have strong ESG governance in place which integrates ESG into pre-investment activities, screening and then throughout the whole strategy duration.
  • Develop a robust ESG strategy in line with key ESG priorities, with supporting policies, processes, and procedures.

Evidence & measurable targets:

  • Have clear targets and KPIs to communicate ESG performance over the long-term.
  • Ensure that if evidence cannot be substantiated, it is not used.

Stakeholder/shareholder engagement:

  • Take clients on the journey to help them build trust and confidence in ESG approaches.
  • Educate and upskill employees on the risks of greenwashing (accidental or intentional).

Outlook

I firmly believe that active management of the value chain, both before and after acquiring an asset, is essential to ensuring climate-related risks are identified and addressed during due diligence processes. It is crucial to establish processes and long-term ESG strategies that both strengthen asset resilience while also detecting issues early on to safeguard the assets’ baseline. This becomes even more relevant as insurance companies grow increasingly reluctant to provide full coverage against climate-related events -we cannot become complacent.

I believe the requirements needed to maintain profitable investments in 5-10 years’ time will progress significantly as our understanding of, and the technology to respond to, global sustainability challenges evolve. Staying at the forefront of ESG and its integration into investments from an investor demand, regulatory and investment insurance perspective, has never been more paramount.

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