This is the fifth in RI’s ‘The EU Action Plan: What Matters To Me’ series, providing insights from market experts on the implications of the EU Action Plan on Sustainable Finance. Today, Hermes’ Ingrid Holmes discusses the need to move from climate awareness to climate action in Europe.
The EU Action Plan for sustainable finance has excellent intentions. It has been praised since its inception as a genuinely progressive and encouragingly ambitious strategy for the establishment of a sustainable financial system. Much of the plan is centred around encouraging more open and informed discussion between companies, governments and investors. Primarily, the plan encourages dialogue on the role that good governance, and the acknowledgement of environmental and social risks, can play both in the delivery of better financial and societal outcomes.
The new European benchmarking and disclosure regulations aim to facilitate this by ensuring that asset owners are considering climate and wider environmental, social and governance (ESG) risks as they select benchmarks and award mandates – and that their asset managers are integrating these factors into their investment processes and decisions.
To be aware of climate change and other ESG risks is only the first step. The next is to act – and it is not sufficient to simply have a blanket plan to divest.
The urgency of the climate and environmental crisis allows for a strong public policy case to be made for tools to help laggards within financial services to catch up with the leaders and quickly get to grips with what counts as sustainable investment and what does not. That is what the sustainable taxonomy aims to do. It sets out a list of what can or cannot legitimately be considered a sustainable economic activity, starting with climate mitigation and adaptation activities. By setting up a taxonomy that can be used by corporates, investors and governments and regulators, it creates a common language for companies and their investors to agree how companies can transition their activities to be fit for the future. If, in due course, it used to implement Ecolabels for funds and underpin an EU green bond standard, it will also help address greenwashing concerns through providing rigorous consumer protections.
This is much needed. In the absence of policy certainty, the divergence which currently exists between various definitions of what ‘green’ means, can lead to scepticism from clients on whether projects and funds actually do deliver the sustainable outcomes they claim to. This, in turn, undermines the market growth potential we will need to see if we are to address the current environmental and climate emergencies while we still have time.
The taxonomy will also potentially encourage more systematic reporting by corporates on sustainable business activities.As the quality and consistency of information disclosed by companies and indeed investors improves, the quality of the discourse between companies and investors around these issues improves too. This should lead to more effective integration of ESG factors into investment decision-making and pricing of capital in a way that captures ESG factors. But it should also improve the quality of dialogue between companies and their investors – a crucial means through which to accelerate the transition to a sustainable economy.
Looking ahead, it is this that we need to see much, much more from investors.
The Shareholder Rights Directive update, which sits outside the EU Sustainable Finance Action Plan, is another important innovation in this space. It foresees shareholders becoming much more involved in the stewardship of their investee companies. It’s not quite a Stewardship Code for Europe, but it is certainly a step in the right direction.
This is where the European Commission should focus next. To be aware of climate change and other ESG risks is only the first step. The next is to act – and it is not sufficient to simply have a blanket plan to divest. At face value a blanket policy to divest might make sense – if a company is acting irresponsibly or there are systemic risks, then surely the responsible thing to do is to not invest there? However, these securities will then simply be purchased by other investors who may care a lot less about the issues. As a result, divesting will not necessarily produce positive outcomes, unless every single investor across the industry agrees to do so in unison – a practical impossibility, for who would there be to buy? If there are no immediately material reasons for divesting, then a more productive solution is for investors to actively engage with companies on ESG issues where there is the potential to see change happen, and in doing so, encourage them to make those positive changes.
Active engagement is an absolute necessity in the face of the climate emergency. If, as investors, we are to reach the greenhouse gas emissions reduction goals laid out in the Paris Agreement, we need to act quickly and in earnest. That is what we at Hermes have been doing as part of our partnership with Climate Action 100+, driving a change in the attitude of major multi-nationals including BP, AP Moller Maersk and Anglo-American. We need others to continue to join the effort.
That is why we need to see, in the next phase of the EU Sustainable Finance Action Plan, a commitment to introduce a Stewardship Code for Europe, building on what has been put in place through the updated Shareholder Rights Directive. It could be used as the basis of a kite mark applied to the investment firms and products focused on actively driving the transition to a sustainable economy – sitting alongside the Ecolabel for sustainable funds.
In this way the Plan could systemically drive the profound and genuine changes needed to achieve the sustainable financial system that the Action Plan envisages.
Ingrid Holmes is Head of Policy and Advocacy at Hermes Investment Management and a former member of the European Commission’s High Level Expert Group on Sustainable Finance