Conferences on the topic of sustainable finance always have one thing in common – they begin with the observation that this is a niche industry and that globally only a tiny fraction of finance flows are based on more than just short-term returns. So, too, began the second German Sustainable Finance Summit, kicked off in Frankfurt with a critical analysis by Joachim Faber, Chairman of the Supervisory Board of Deutsche Börse AG.
“We continue to do a great deal of talking, but little is actually achieved. The discussions are not very impact-oriented,” said Faber as a criticism both of the policymakers and his own industry, which he argues is not showing much movement. According to Faber, many papers on the topic, including those from business circles, are planned simply as soapbox speeches and lack actual goals for achieving greater sustainability.
However, the tide appears to slowly be turning. For the second time, the Hub for Sustainable Finance, which was founded by Deutsche Börse AG and the German Council for Sustainable Development (RNE), hosted a German Sustainable Finance Summit – with twice as many delegates from the field of politics, the finance sector, science and civil society as last year. There appears to be a reason for this high degree of interest: Alexander Bassen, Professor of Capital Markets and Management at the University of Hamburg and Council member, spoke of a “regulatory sword of Damocles”.
EU action plan results in action
Bassen spoke about the European Commission’s March 2018 action plan on financing sustainable growth, the aim of which is to see to it that the EU implements the Paris Agreement and the United Nations’ 2030 Agenda. This was followed in May by the introduction of a set of measures for implementation of the action plan. Two aspects of the Brussels proposals were discussed in depth at the conference in Frankfurt:
Taxonomy: One of these is that all EU member states are to agree on a common definition of sustainable economic activity in the interests of the environment – the technical term for this is taxonomy. This can subsequently serve as the basis for a common EU-wide label for sustainable investments, possibly along the lines of the organic food certification mark. According to the Commission’s current proposal, this classification system would apply to all financial market players wishing to offer green, sustainable, environmental or similarly labelled financial products. A group of experts has been working on this since June. The taxonomy will initially only cover environmental criteria for sustainability, not social and governance criteria. A hearing of experts will be held in this regard in Brussels on 18 October. At the conference, Martin Koch, Policy Officer within the European Commission’s DG FISMA, explained that the Commission’s aim was to prevent the EU market for green, environmental and sustainable finance products from becoming fragmented and that a clear framework was needed, especially for cross-border investments.
The planned taxonomy was discussed in depth by the Summit’s participants. Criticism was voiced of the fact that the taxonomy would only apply to explicitly green financial products. As such, the classification would not affect anyone not wishing to label a fund, an insurance policy or some other financial product as sustainable, green, environmental or any such term. In addition, it only applies to financial products, not companies. An enterprise could therefore invest in coal but still launch a financial product to finance wind farms which is labelled as being green. Molly Scott Cato, a member of the European Parliament for the Green Party of England and Wales, said that the taxonomy was a breakthrough that should be feted. “But there is no black-list, and that’s definitely not green. Without this, the taxonomy isn’t terribly useful,” she said in criticism. Koch defended the taxonomy, stating that it had six clear fundamental environmental principles. Green investments would have to be of benefit to at least one of these, such as climate protection, and may not be detrimental to any of them, for example protection of the oceans. Levin Holle, Director General for Financial Markets Policy within Germany’s Federal Ministry of Finance (BMF), said the taxonomy was very important, but warned against being too hasty: “If we get the taxonomy even slightly wrong, we run a great risk of sending a lot in the wrong direction,” he said.
Disclosure requirements: According to Holle, there are two other aspects of the EU reforms which are more pressing for the Federal Ministry of Finance in view of the EU elections in just six months’ time, namely the so-called low-carbon benchmarks and the requirements regarding the disclosure of sustainability aspects. The former are uniform EU-wide benchmarks for the environmental damage caused by the economic activities that investors invest in – investors could then use these benchmarks to make their investments more environmentally friendly. In addition, there are uniform benchmarks for rating the positive impact of investments in climate protection – these are called positive-carbon benchmarks.
The disclosure requirements were the subject of intense debate at the conference. Unlike the taxonomy, these would apply not only to green financial products, but to the financial market as a whole. The European Commission presented a proposal for these in May. The regulation lays the foundations for environmental, social and governance aspects – the ESG criteria for short – being placed at the heart of the financial system. Its purpose is also to make Europe’s economy greener and more resilient and to establish a circular economy, according to the European Commission’s proposal.
The plan is for a number of existing directives and regulations to be amended. All financial market players who manage money for their clients in anything from risk capital funds to pension insurance policies will then be obliged to take ESG criteria into account in all of their investment decisions. They will be required to regularly report to their clients on how they do this. They will also be required to always disclose to their clients the effect that sustainability aspects will have on the value of an investment. “Taking sustainability criteria into consideration is part and parcel of analysing the opportunities and risks of financial undertakings,” said BMF representative Holle.
This is founded on the lesson learned that businesses or portfolios that consider ESG criteria achieve the same return but with fewer risks. “What I think is lacking is the finance sector seeing this more as a business opportunity,” said Chairman of the Deutsche Börse AG Supervisory Board Faber. Together with climate protection and the UN’s 2030 Agenda, this so-called risk-adjusted return on sustainable investments is the second reason why the European Commission is expediting the topic – it believes that a financial system which takes ESG criteria into account is more stable because it involves fewer risks. One of the criticisms levelled at the disclosure requirements during the conference was that having to incorporate ESG criteria into risk management would not make a financial activity automatically more sustainable. Many of the attendees were also still entirely in the dark as to how the new requirements would be incorporated at a practical level into the day-to-day activities of, for example, a portfolio manager.
Expertise, primacy of the policymakers and education
The EU reforms weren’t the only topic discussed at the Summit. The speakers’ and attendees’ key messages included the following:
- The field of politics needs to have primacy over the markets: The policymakers must ensure that the new principles and transparency with regard to sustainability matters are actually observed in the world of finance. Additionally, they must not back away from what has already been decided: “The most important political battle in the years to come will be to get politicians across the spectrum to stick to the goals of the Paris Agreement,” said Molly Scott Cato.
- Establishing role models: Public institutions and the policymakers must actively practise the values and see sustainability as a top priority. Marlehn Thieme, Chairwoman of the German Council for Sustainable Development, called for the policymakers to not only regulate the financial markets, but also act as role models themselves in the case of government investments.
- Developing expertise: There is a lack of basic knowledge of sustainable business practice in many areas, be it in vocational training, university studies, career experience, or on supervisory boards and within federal institutions. There is therefore a need for further education and new textbooks. For example, Ralf Frank, Managing Director and Secretary-General of the German Association for Financial Analysis and Asset Management (DVFA), took a look at various training programmes for investment professionals as part of a study. “The topics of ESG and sustainability didn’t feature in any of the textbooks,” he criticised.
Documentation of the Summit’s findings will be published on the website of the Hub for Sustainable Finance in the next few weeks.
Michael Schmidt, Head of Asset Servicing and Alternative Investments at Deka Investment, summed up what was certainly the key finding of the Summit as follows: “The circle has got bigger. The stone thrown into the water by the EU is throwing ripples and is now impacting more than just those who are enthusiastic about sustainability,” he said.