Where do SDGs fit into new EU green finance rules?
As new EU disclosure regulations await the finance industry, Geneva-based adviser Ground_Up Project explains why companies and investors may benefit from using the SDGs and how they align with the new rules.
Green investing is becoming increasingly popular. Over the last few years, we’ve seen demand to invest in funds that focus on environmental and social governance (ESG) issues worldwide, with sustainable assets under management soaring by 62 per cent to CHF 1.16 trillion in 2019 in Switzerland alone. This is especially good news when considering that this increase has occurred voluntarily, with Covid-19 seeming only to have accelerated this move to more socially responsible investing.
But for the European Union, this shift is not happening fast enough. For example, to reach its Paris Agreement goal of a 40 per cent cut in greenhouse gas emissions by 2030, the EU believes that private capital will be required. For this reason, the EU has created the Sustainable Action Plan, a series of legislative measures, to incentivise, and where necessary, compel investment managers to make private capital available to fill the estimated €180bn per year gap.
This is where the EU’s new Sustainable Finance Disclosure Regulation (SFDR) comes into play. The new framework, delayed for now but due to come into force this year, will force investment managers to up their game on ESG and bring more transparency around the sustainability of their products.
The SFDR works alongside the EU taxonomy, a framework for economic activities needed to support the transition to a low-carbon economy. Aimed at cutting through the “greenwashing”, these rules will help establish performance criteria to differentiate sustainable from non-sustainable economic activities and therefore from sustainable and non- sustainable investments. And it’s expected to radically change how investors and companies report on their environmental performance.
These initial regulations cover all EU based investors and advisors across all asset classes. But for the Swiss financial sector, there are also implications. According to law firm Baker McKenzie, “it is in our view likely that sooner or later, the Swiss Financial Market Supervisory Authority (FINMA) will require Swiss financial institutions to comply with ESG principles to a certain extent.”
Responding to the International Financial Reporting Standards (IFRS) Foundation’s Consultation Paper on Sustainability Reporting, published in September, the European Securities and Markets Authority (ESMA) commented “international sustainability reporting standards should use the SDGs as an underlying anchor”. This reinforces our understanding that the EU is also looking at defining other investment product labels, such as “impact” and “SDGs”, both of which are widely used by the sustainable investment sector. Bringing these labels under the jurisdiction of the SFDR would logically fit within the EU’s thinking behind the Sustainable Action Plan.
These new rules come at a time when sustainable investors are looking for better results as the industry matures. Researchers at the University of Zurich’s Center for Sustainable Finance & Private Wealth recently noted, “industry focus is now shifting from a capability to an alignment approach, meaning looking at action effectiveness on sustainability rather than ability to take action”.
The impact of EU rules. Regulations of financial products or changes in fiduciary duty do not make for great reading but are incredibly important to the asset management industry. For those concerned with attracting private capital to impact driven companies, especially in emerging markets, it could be an immense boost of demand.
Once asset owners, both institutional and retail, begin to understand these new disclosure rules and compare investment products, the limits of some sustainable investment products will be evident. People will ask “how green is an investment in Volkswagen Group (the second largest EU based listed company) or Walmart (largest US listed company)?”
For many investors, this will not be sustainable enough. Younger investors, especially those inheriting large (and growing) family fortunes in the coming years, are already demanding more transparency with their sustainable investments. As asset managers and their clients reassess their portfolios across the EU and Switzerland, a small change in allocation could create billions in demand for more sustainable, SFDR compliant investments.
Finding more impactful, sustainable investments. Better use of the SDGs could offer a solution. Our research has found that if asset owners, investment managers and entrepreneurs could link their impact more directly and clearly to the SDGs, there would be multiple potential benefits in terms of risk, return and impact.
On the investor side, asset owners could lower their risk, maintain their required level of returns and have more strategic impact which would be clearly linked to the SDGs. Investment managers could have the same results plus the benefit of labeling their investment products in compliance with new and future SFDR regulations.
Entrepreneurs, who in the end create the impact investors are looking for, could benefit from better financing terms, easier fundraising, additional incentives and support. Overall, the sooner the regulations are introduced, the sooner they can present a win for all.
Steve Rocco is managing director of The Ground_Up Project, a Geneva-based advisory company that partners with local and international business networks and other international organisations to source investments that contribute to national SDG roadmaps worldwide. This article was published in partnership with the UN’s SDG Lab.