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Green shoots: Germany’s new Hub for Sustainable Finance (H4SF) takes root

The elements for the rise of ESG in Germany are coming together…slowly.

The seeds for growth in sustainable finance within the German finance industry are being planted, raising the question of when they will start to bear fruit.

One major new fertiliser is the Hub for Sustainable Finance (H4SF), a coalition that bundles the voice of German sustainable finance initiatives, and which held its first summit in Frankfurt at the end of October. Sponsored by the Federal Ministry of Finance, it gathered influential institutions like Deutsche Börse, BaFin, the financial regulator, and state bank KfW. The Hub was initiated by the Deutsche Börse and the German Council for Sustainable Development (RNE) and advises the German Federal Government in Berlin on sustainability issues. Its establishment is said to have been prompted by the German G20 presidency this year under the influence of international initiatives like the EU’s High-Level Expert Group on Sustainable Finance (HLEG), the Task Force on Climate-related Financial Disclosures (TCFD), the UN Sustainable Development Goals (SDGs) and the Paris COP21 Agreement. Its establishment is already noteworthy because Germany is known for lacking a deeply rooted sustainable finance history: link to RI article.
ESG investments make up only 2.8% of the total investment market. Kristina Jeromin, Head of Group Sustainability at Deutsche Börse, says that it was launched because the exchange’s key finding in dialogues with companies and investors was “that we need to get sustainability out of the niche and into the mainstream of international capital markets”.If Germany does not integrate sustainability into its financial system, Professor Alexander Bassen, member of the RNE, sees a danger that in three or four years’ time “international clients won’t find business in the German market as attractive, and the entire German system could potentially suffer a competitive disadvantage.” Jeromin agrees that it is about making Germany’s industries ‘future-proof’, while seeing a larger role for the nation: “There will be high funding requirements globally for the sustainable reorganisation of whole branches of industry and major infrastructure projects, the achievement of the Paris 2-degree goal and the realisation of the SDGs. A decisive role for Germany as an advocate of sustainable development, also through an improved financial system and with suitable financial instruments, is a necessity in an international and a multilateral context as well.”
The shift to a low carbon economy poses opportunities and risks for investors and companies.
Christian Thimann, chair of HLEG and vice-chair of the TCFD, says some assets are clearly at risk from the transition, especially physical risks from natural catastrophes, and then related legal risks. He points in particular to three ‘systems’ that are being disrupted: the energy system, transportation and the food system. A consequence, Thimann says, could be wider disinvestments: “So far, disinvestments have focused on the energy sector by investors. I wouldn’t be astonished if at some point they occur in the food sector too, as the way much food is produced and transported is damaging natural capital and harming soil, water and biodiversity.”

So-called transition champions – companies that are superior in handling the challenges – could emerge simultaneously.
In his speech at the H4SF summit Ludger Schuknecht, G20 finance deputy and Director-General at Germany’s Federal Ministry of Finance, said: “It is possibly even more important than assimilating losses derived from stranded assets that transition champions will have to be identified and financed.”
One possible way for investors to identify transition champions could be via the TCFD report, suggests Thimann. He describes how he believes the winners and losers of the future system will look: “Taking the TCFD scheme, the winners have governance on climate-related risks and opportunities, on the board, and with the staff, and look at innovation. […] The losers are those in my view who are disoriented about the situation, who don’t have the expertise, and who don’t look at climate-related risks and opportunities in their strategy and long-term planning. From what I see, it will not be black and white, but we will rather see relative winners and relative losers.” H4SF has devised ten theses from numerous reports and papers produced by HLEG, the Principles for Responsible Investment (PRI), the RNE, the Deutsche Börse, and the TCFD: Link

Their aim is to define “the key areas for action with respect to implementing a sustainable financial system”. They served as a basis for discussion at the first summit. Dustin Neuneyer, Head of Continental Europe at the Principles of Responsible Investment (PRI), said, optimistically: “The ten theses were prepared so that they can also enter the new coalition agreement and government program of the future government, and will be realised.”
One of the theses recommends that the state-run or government-associated financial sector organisations and funds ought to function as role models to promote sustainable development. According to Professor Bassen, when invested in sustainable finance, the volumes of these state funds can move the market. Whether state funds should take on this leadership role is still disputed among the H4SF members, with proponents like Neuneyer arguing for conformity of investments with the politically decided aims of the Energiewende renewables transition, and the likes of Schuknecht arguing for a cautious approach for now.The German finance ministry recognises the materiality of environmental and climate related risks, and is promoting the integration of environment and climate risk management in lending and investment decisions. The €24bn nuclear waste disposal fund founded in July this year and consisting of deposits of nuclear power plants operators, RWE, E.ON, EnBW and Vattenfall, has already been decided to be invested according to ESG criteria in the near future. The fund’s investment guidelines stipulate the integration of ESG criteria into its strategy. However, in Schuknecht’s opinion, federal pension funds could only play a limited and not a leading role at a time when methodologies on ESG risks are still being developed by the financial industry. Nonetheless, in Germany’s occupational pension schemes, a gradual shift can be expected. Occupational pension schemes in Germany are smaller in size when compared with other EU nations, which means they are more atomised in their thinking on big investment issues. Estimates suggest that they represent 12% of Germany’s GDP. As a comparison, in the Netherlands this number makes up as much as 168% of GDP, but that includes also state funds. There are 171 Institutions for Occupational Retirement Provision (IORPs) registered in Germany, and a minority of them have demonstrated leadership on ESG issues, says the Germany Roadmap of the PRI. But these German occupational pension funds will be influenced by the incorporation of ESG issues within the next two years via EU Directives such as the revised Institutions for Occupational Retirement Provision (IORP II) Directive and the EU Shareholder Rights Directive. Further ESG development can be expected from the implementation of the final HLEG recommendations to national level. But change will be steady and cautious. The PRI’s Germany Roadmap concludes that Germany’s finance industry is compliance-oriented and that investors will seek to fully comply with the regulation, but not seek to go beyond it.