RI in Germany Special Part 3: laying the ground for building ESG

Sign up for a free trial to Responsible Investor

Sustainable finance initiatives have been rather fragmented in Germany. Even the nation’s massive Energiewende transition from nuclear to renewables and a low-carbon, energy-efficient economy has lacked a systemic approach to integrate Germany’s financial sector in the transformation.
Werner Schnappauf, member of the German Council for Sustainable Development (RNE) and Senior Advisor at Bank of America Merrill Lynch EMEA, sees bringing in investors to the transition as a necessity: “Only if the financial sector recognises that flows must be diverted to ESG will we be able to drive change substantially”.
The problem, however, is structural. Germany’s economy is bank rather than capital-market dominated, and the country is inclined towards a savings rather than speculative culture. These are just two reasons why ESG investing has struggled to grow to date (see article one). However, observers believe outside pressure from regulation and a burgeoning sustainability movement at the local/regional level could start to align the pieces. Ingo Speich, portfolio manager at Union Investment, says the transposition of the EU Shareholder Rights Directive and the revised Institutions for Occupational Retirement Provision (IORP II) Directive, could lead to a rise in sustainable finance in Germany in the near term. And proactive ESG moves within the German market are increasing, notably from cities and federal states.
Within the last two years, Berlin, Göttingen, Münster, Bremen, Osnabrück, and Stuttgart have all made steps in ESG investment or divested from fossil fuels with their treasury money. At the beginning of 2017, Berlin published an ESG index and made it available for other federal states to use for their investments. Three federal states, Hessen, Baden-Wuerttemberg, Nordrhein-Westfalen, have set up a working group to develop an ESG index with the help of the Bundesbank. The State Secretary at the Ministry of Finance of the State of Hessen, Martin Worms, says that sustainable finance is rising in importance in financial policy. He says it is a chance to attract new investors and apply a “debt brake” to state funding, which is fundamental for inter-generational justice.This demand by cities and federal states for sustainable finance led to the central bank suggesting the development of a national ESG standard for investment. At the beginning of December, 2017, the Bundesbank organised a portfolio day on sustainability – the first of its kind – which Worms says would have been “unthinkable” five or ten years ago. On the day, the Bundesbank presented to the assembled federal states on the rationale and profitability of sustainable investing. The Bundesbank plans to produce its national standard based on the needs of the federal states. When achieved, Worms says, the standard will at a minimum trigger financial flows towards sustainable finance by the states “at a large scale”. Joachim Wuermeling, a board member of the Bundesbank, says he believes it will make others follow suit: “Standardisation driven by the public sector gives a signal and results in higher trust, higher reputation and potentially higher authority than standards that are developed by private fund companies. Such a standard developed by the federal states with the Bundesbank will draw interest and be a reference. Also, the public sector can show that sustainable investment, especially of pensions money, is meaningful and economically reasonable. I am certain that these examples will be looked at intensively by others.” At the national level, there are plans for the EUR24bn nuclear waste disposal fund to be invested according to ESG criteria. The fund holds the deposits of nuclear power plants operators RWE, E.ON, EnBW and Vattenfall. Yet, when comparing the federal state and national civil servant funds, the latter are lagging in ESG investing. Worms assumes that one reason for this is the considerably smaller proportion of personnel expenses, making up about 8-10 per cent of the national budget compared to 40 per cent of the regional budget, depending on the basis for assessment.
“The national budget consists of financial streams and is to a lesser extent a personnel budget,” he explains, and this is probably why problems on provisions for future pension liabilities have much less importance for the national government than for the federal state government.
 Another reason, he says, is the
market situation: “The national government reacts more to market conditions. And there is probably so far no demand by investors. If the market demands more green finance, it will surely promote the thinking process and the decision-making process of the national government. But at the moment, the market is too sluggish in Germany”, he says.
 In Hessen, which began in 2006 with ESG investment, it was the Green Party that initially brought the topic onto the agenda. But while the Greens have been pushing on sustainable finance in the federal states, in the national government its influence has been much weaker because the party hasn’t been ruling since 2005. Political leadership on sustainable finance at the national level is needed, but Gerhard Schick, a Bundestag member for the Green Party, doesn’t expect it. Most political parties, he says, have an industry policy that protects domestic industries. Heavy CO2 emitters in Germany like the car, coal and oil sectors are “massively applying the brakes on the subject of a renewable energy shift”, he explains. With the German G20 presidency in 2017, green finance finally reached the German Federal Ministry of Finance, but Schick laments that this was far too late given the importance of the issue since many years at the C-Suite level. And while awareness and support for the topic is growing in the Ministry, it is showing caution when asked if public funds should be invested according to ESG criteria (see article 2). Without national government backing, Germany is likely to remain a sustainable finance laggard behind nations like France and Sweden.Schnappauf explains that the sustainable finance standardisation process is a matter of coordination of many policy actors across Europe. He says: “The whole will most likely succeed when it is understood as a collective mission where everybody makes a contribution.” Still, federal states and cities will continue to drive progress to some extent. The Green Finance Cluster, a sustainable finance initiative that was initiated by Tarek Al-Wazir, Green Party Economics Minister in the state of Hessen, may become more important. Its founding members include KfW, the German state development bank, and the Center for Financial Studies, and its sponsors include Deutsche Bank, Deutsche Börse, and Dekabank. Al-Wazir said: “A sustainable alignment of the financial system is indispensable. […] It is important that Frankfurt articulates an internationally noticeable voice [in the transformation process], as cities like Paris and London are dominating the discussions at present.” Despite its recent launch, Speich says the Cluster still needs to come alive. How much it can achieve in creating standards, he says, remains to be seen. Importantly, it will have to overcome the difficulty of finding a common denominator for the large heterogeneity of the members and their conflicting business models. There is progress towards building national initiatives and ESG standards in Germany, but their realisation will not be straightforward.

Read the RI Germany special series:

Part 1. “How can it be explained that a nation leading in sustainability like Germany, is equally lagging in its financial system [in sustainability]?” Link to article

Part 2: The elements for the rise of ESG in Germany are coming together…slowly. Link to article