It often takes an experienced Kremlinologist to divine the true message and meaning of European Commission missives, and their Action Plan on Sustainable Finance is no exception. Taken at face value, this plan is the panacea for all our woes – at least it would be, even if we were to accept only a plurality of its many assertions. In the last week, I have been to a lot of conferences, roundtables and dinners on responsible investment, which have confirmed to me that the Plan may be prayed in support of any and all things by any and all people in this community – a grouping that now contains far more advisors, commentators, consultants and other service providers than investment principals, all with their own agendas.
It has been thirty-one years since Brundtland described sustainable development as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs’‘. The Action Plan (presumably) adopts its own High Level Experts Group’s much more expansive, and exclusive, description:” Sustainability means making economic prosperity long-lasting, more socially inclusive and less dependent on exploitation of finite resources and the natural environment.” The Plan does state: ‘Sustainable finance’ generally refers to the process of taking due account of environmental and social considerations in investment decision-making,” but then asserts: “…leading to increased investments in longer-term and sustainable activities.” – for which there is no supporting argument or evidence offered. Against this background, it was surprising to hear, frequently from practitioners, sustainability described solely in terms of externalities arising from corporate behaviour – their (negative) effects on others not directly involved. In fact, sustainability is usually determined to a far greater extent by the fairness of the arrangements among stakeholders within an enterprise. It is crucial to defined benefit pensions.
The published Plan also contains some highly questionable interpretations, presented as fact, including one that has been challenged by trade associations such as EFAMA and Pensions Europe.According to the Commission, investors do not take into account adequately ESG factors – the observable here is not what investors do or don’t consider in their investment appraisal process, but the fact that investors have not financed more of the Commission’s wish-list of projects. The observed phenomena, lower than desired levels of investment, may have many other causal interpretations, such as: we considered all aspects, and found the projects or investment forms unattractive. The nub of the issue is: “Current levels of investment are not sufficient…” with annual shortfalls variously estimated at €180 billion to €270 billion. But there is nothing in this plan to encourage increased savings and investment. This is all about reorientation of existing flows. There isn’t even any consideration of how those deprived of finance by such “reorientation” are likely to respond. There is an embedded but unstated interpretation here also – that the problem of the unfulfilled wish-list is one of investor demand. My own experience of infrastructure finance, and that of many surveys, runs counter to this, and is that investors have allocated funds to the asset class but have been unable to find suitable investments. In other words, that the problem is one of supply.
The principal proposal is: “A unified EU classification system – or taxonomy – will provide clarity on which activities can be considered ‘sustainable’.” which will be “gradually integrated into EU legislation to provide more legal certainty.” The ambition is boundless; the threat unstated but certainly implied. Whatever happened to the economics of incentives? Let me suggest a name for this body, one which has gone unused since the Soviets abandoned it in 1991: Gosplan. Doubtless we can expect an ongoing sequence of five-year plans, comprising revisions and corrections, and yet more regulations. The Plan also proposes to “clarify investor duties”, but continues with: “…will aim to (i) explicitly require (emphasis added) institutional investors and asset managers to integrate sustainability considerations in the investment decision-making process…” This is a direct intrusion into the very heart of a professional
investor’s business process. It would be the death knell of passive investment as we know it. As importantly, it prompts the question: who is liable for problems and losses arising? The warped Orwellian “clarification” should concern all in a position of agency and its related fiduciary duty. As for principal investors, the infringement of rights is much more basic, and troubling. Doubtless, we may rely upon the legions of auxiliaries, the advisors and consultants, to police these requirements, and expect that to be with a zeal reminiscent of the NRA’s defence of the US Second Amendment. Indeed we already are seeing much similar involvement in the consultation and drafting processes; complicity is the word that comes to mind. The plan contains ten action points, several of them multi-part. It divides these into “necessary” and “complementary” (to the taxonomy), with this being further divided into public and private investment. The “necessary” consists only of sustainability benchmarks and EU labels for financial product standards – if only they had left it there. The complementary are divided into public and private investment, where there are twice as many actions for private as for public. The public investment actions are all rather vague and woolly bullets: fostering investments, policy-making process and European Supervisory Authorities’ role. By contrast, the private sector actions are all explicit. They are clearly an attempt to be all encompassing – we are even promised that the ‘problem’ of short-termism in financial markets will be tackled. The scope is extremely wide – accounting, corporate governance and non-financial reporting, green bonds, sustainability benchmarks and eco-labels, credit ratings and research, and even advice get their moment in the sun. There is something here for everyone; no special interest lobby group goes unrewarded. One of the few positives with this publication is that some of the more insane earlier proposals, such as the use of regulatory (risk) capital requirements as incentive mechanisms, have been dropped.
Of course, in promotion of its cause, the plan draws attention to the well-publicised increase in climatic events, and their economic consequences. A cynic would say that one can always enlist the spectre of risk in support of regulation – after all one of the few things that we know about risk is that it means that more things may happen than will. The creation of an atmosphere of uncertainty, of great apprehension and dread, along with the promotion of remote possibilities to probabilities, is deeply troubling.Experimentation and innovation are then much simpler to depict as irresponsible and dangerous. It paves the way for millennium bug hysteria at its most extreme. We would do well to remember that if we make precautionary provision against every possible future event then we may well be unable to feed or clothe ourselves adequately today. Go back to Brundtland. And on this subject and its sometimes-perverse logic: the absence of evidence does not constitute proof that precautionary action needs to be taken. There is no indication at all of the costs of implementing this hodgepodge of new regulation, or of the effects of those costs on the attractiveness of sustainable investments. It is also notable that the international dimension passes largely undiscussed, when there are some success stories, such as the IFC’s emerging markets infrastructure initiatives, from which we may learn. There is a relative success story buried in the Plan -the European Fund for Strategic Investment (EFSI), where one third of its investments are climate related. Given that success and the many and large public benefits held out by the authors of the Plan for this investment, the obvious question is: why are we not doing as much as possible of this investment in the public sector? According to the Plan, these investments, with all of their gains and benefits, would effectively be self-financing – certainly government borrowing for these purposes could easily be financed. The various social and other benefits may be extremely valuable to that society, but if, as a private investor, I cannot capture some part of them, they are irrelevances for my financial decision-making. This Plan is motivated by a desire for more “sustainable” investment, but that really only means the Commission’s infrastructure wish-list, and that, like the UK National Health Service’s budget, knows no upper bound; there will always be unsatisfied further demand. The proposals contained in this Plan taken together amount to financial repression, though presented in a manner worthy of Potemkin. Make no mistake, the aggregate effect of financial repression is to lower saving and investment, not increase it. Cronyism and favouritism in project selection are commonplace under systems of repression. I share wholeheartedly a desire for greater sustainable investment and the social benefits which that may bring; my problem is that this proposed Action Plan seems more likely to hinder than help progress to that objective.
Con Keating is Head of Research at BrightonRock Group.