Last week’s interim report by the European Union’s High Level Expert Group on Sustainable Finance has much to commend it, like the proposals for EU-level principles of fiduciary duty, a label for green bonds and a green infrastructure hub.
And some of the details buried in the report will spark a lot of interest, such as the notion that there should be an EU-wide equivalent to France’s Energy Transition Law, Article 173, which requires pension funds and others to report how their investment policies align with the national strategy of energy and ecological transition. The report provides plenty of food for thought, like the notion that responsible ownership is “a public good” and “intervention is required to preserve and maximise it”.
But as the report itself acknowledges there is “no single parameter that could switch off ‘short-termism’ and move finance to the long term”. So it’s maybe unrealistic to expect the report to be too ambitious: the aim seems to have been to focus on the feasible and achievable.
The talk beforehand was that it would contain some hard-hitting regulatory proposals. But, frankly, there are surprisingly few of these in the report – meaning that in some key areas it has more bark than bite.
For example, credit ratings agencies will be breathing a sigh of relief that there is no substantial regulatory pressure on them in the report.
And the 72-page report only finds space for five paragraphs on stock exchanges, and no mention whatsoever of exchange listing requirements. There’s no reference to portfolio holding periods, short-selling or hedge funds – all topics that need to be addressed in order to achieve a genuinely sustainable financial system. Private equity rates one mention in passing, as does real estate. There is no mention of actuaries, securities lending or family offices at all in the document.
Take the section on Solvency II. This has long been a bugbear for those in the sustainable investment sector for discouraging long-term investments – which the report fully acknowledges, to its credit.
The report makes this suggestion: “Possible implications of the ‘market-consistent’ valuation approach currently applied in Solvency II on long-term products and investments should be investigated.
“Attenuation of some constraints to enable investment in equity and long-term assets should be considered. European supervisors could insist and ensure that long-term sustainability factors are incorporated in the ORSA [Own Risk and Solvency Assessment] made by insurance companies.”
In my view, this form of wording stops well short of a clear-cut proposal. Rather it is a statement of the obvious and merely serves as a ‘nice to have’ rather than a regulatory redline. And top officials Valdis Dombrovskis and Jyrki Katainen don’t mention these issues in their foreword to the report.Despite speaking about the need for “deeper re-engineering” of the financial system, the two European Vice Presidents put their considerable weight behind a classification system for sustainable assets and a European standard and label for green bonds.
“These labels,” they say, “will provide the confidence and trust in sustainable and green products needed for investors to fund the transition to the low-carbon economy,” they say. Important work no doubt, but hardly “re-engineering” – and hardly the real remit of regulators?
And what about existing fund structures, created during an earlier push towards sustainable investment, such as the European Long Term Investment Fund (ELTIF) and European Social Entrepreneurship Fund (EuSEF)? They barely rate a mention and the suspicion must be that they are consigned to the margins.
Instead of concrete regulatory proposals, the report prefers to express itself differently, using the term “policy direction”.
Here’s an example: “Embedding sustainability into stewardship codes and asset management agreements, and requiring asset managers to disclose how they integrate ESG factors into their strategy and vote on ESG issues, are all part of the measures that could be pursued to strengthen the ownership chain.” Fine words, but where’s the specific regulatory beef?
On investment mandates, the report has this to say: “A further step would be to embed sustainability within the mandates, investment policies and risk management frameworks of institutional investors. ” This surely needs greater development over the next six months, if the final recommendations scheduled for December are to carry any real weight.
Investment consultants are touched upon, with the report saying that in markets that are consultant/intermediary-led, the governance arrangements of pension funds can be a barrier, limiting “the ability of pension funds to deal with emerging risks, and especially long-term sustainability risks”.
On this note the HLEG supports the recommendation that advisers to institutional investors “should have a duty conferred on them to raise ESG issues pro-actively within the advice that they provide”.
One section of the report does a great job of encapsulating the issues: “The EU could accelerate the development of new green and sustainable assets and financial products through improved structuring, possibly delivered through blended public/private finance to encourage the development of sustainable securitisations, layered funds, green covered bonds and thematic sustainable funds.” Again, fascinating stuff and much to be welcomed. But how is this to be achieved? The report doesn’t say.
The HLEG throws up a few anomalies too. The report notes how banks, as the “largest asset pool”, have an essential role in the transition towards a sustainable financial system. So it was intriguing that none were involved in the group, with banking body the European Financial Services Round Table (EFR) scrambling to get involved at the last minute.
One odd aspect about the expert group itself is that of the 20 members, seven are from the UK.That’s to day that almost a third of the group are from a state leaving the EU (assuming Brexit occurs), and one that hasn’t taken a lead on sustainable investment in recent years. That needn’t be a problem, but is it a European solution to a European problem?
Admittedly the report is an interim document, and some of the issues mentioned here will no doubt come under discussion at a high-level meeting in Brussels this week. It should be an interesting debate.