This article is one in a series of thought leadership pieces written for Responsible Investor by members of the European Commission’s High Level Expert Group on Sustainable Finance. To see other HLEG coverage, see here, or to comment, visit our discussion page.
As we enter the second phase of our work this month, I believe the High-level Expert Group on Sustainable Finance (HLEG) has a key question to answer: how can we reconnect EU citizens with their savings and investments?
There is a widespread lack of understanding as to how the financial system directs an individual’s capital towards investments, and this is a profound problem for sustainable development. It allows short-termism to permeate the markets and prevents capital from reaching longer-term projects. The recommendations of HLEG should aim to remedy this problem by improving transparency and providing incentives for sustainable corporate and investment behaviour throughout the system. We are looking forward to continuing to work with the European Commission and its staff on this – they have been thoughtful, constructive and appropriately challenging in their engagement so far.
HLEG believes further action across the entire EU investment system will be vital. Firstly, we would like to see better disclosure on environmental, social and governance (ESG)-related matters among financial-market participants. The Commission has promised to publish guidelines that will help companies comply with existing EU non-financial reporting requirements, which is a positive step.But we believe the Commission should go further and engage with the work of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD), an initiative designed to encourage a range of capital-market intermediaries to provide more information on their exposure to climate risks. As a member of the Task Force, I would like to see the Commission push for its recommendations to be taken up across the European capital markets.
Second, ESG should be incorporated in credit-rating methodologies. Currently, a typical credit rating only gives a detailed picture of an institution’s creditworthiness over a time horizon of about three years, even if it is issuing a bond that matures decades hence. Ratings that incorporate ESG criteria will furnish investors with a more holistic, longer-term view of a company’s prospects, and in turn allow investors to provide final beneficiaries with assurances that their investments are safe.
Furthermore, credit ratings are central to how financial markets are regulated: ratings are part of the legal framework that governs banks’ capital-adequacy provisions and the Solvency II legislation for insurers, for example. We believe incorporating ESG into ratings will strengthen these regulatory regimes and help insulate markets against longer-term social and environmental shocks. Third, sustainability and ESG should be more fully integrated into supervisory processes. HLEG would like to see the European Supervisory Authorities (ESAs) play a central role in this. Inaction on sustainability issues is widely acknowledged as a significant systemic risk; as such the ESAs should be addressing it as part of their existing mandates to protect financial stability for EU citizens. However, over the longer term, the
Commission could empower the ESAs to more effectively promote supervisory convergence on ESG issues by coordinating the work of national authorities. We believe the ESAs should take steps to leverage the final recommendations of the TCFD to encourage standardised disclosures on climate-related risks, for example. Fourth, we would like to see the Commission ensure sustainability is incorporated in the investment mandates of institutional investors and asset managers. Key to this process will be clarifying the fiduciary duties of these organisations. Research shows many investors, directors and pension trustees are still under the impression that fiduciaries are required to focus on maximising short-term returns, and that sustainability is an irrelevance. This is false.
The Commission could empower the ESAs to more effectively promote supervisory convergence on ESG issues by coordinating the work of national authorities.
Under the existing rules, fiduciaries have a duty to act with due care, skill and diligence; investing as an ‘ordinary prudent person’ would do. An ordinary prudent person would not ignore climate-related risks; that much is clear. But we believe fiduciary duty runs deeper than this. Would a prudent person like to see their money used to despoil the planet or exploit their fellow human beings? By clarifying that fiduciary duty should encompass these broader considerations, the Commission should encourage investors to actively seek their clients’ views and consent on these matters, and deploy their capital more sustainably.Again, this is about improving understanding and bringing individuals closer to the investments being made on their behalf.
Finally, we need to create a race to the top among companies in their sustainability performance.
To what extent are the largest companies in the EU and across the world contributing – or failing to contribute – to a more sustainable future for the world’s citizens?
The EU should consider how it can support the recently-launched World Benchmarking Alliance, which aims to publish free, publicly-available league tables ranking companies against their performance on each of the Sustainable Development Goals. This will empower citizens by enabling them to see where their money is being spent and invested.
The Commission has pledged to act on the conclusions of HLEG next year as a matter of priority. I look forward to working the rest of the group to ensure these proposals are taken forward. But we cannot forget that the ultimate audience for our proposals is not the Commission, other businesses or Member State governments – it is the EU citizen whose interests should lie at the very heart of our financial system.
Steve Waygood is Chief Responsible Investment Officer at Aviva Investors. He is also Chair of the Corporate Human Rights Benchmark, co-founder of the Sustainable Stock Exchange Initiative and a member of the Financial Stability Board’s Task Force on Climate-related Financial Disclosure.
To give feedback on the HLEG’s interim report, published in July, see here.