Why ESG ? The rationale behind sustainability in finance

Find out in our latest contribution to Seqvoia’s blog

Is sustainability an ephemeral trend or is it a game changer ?

Climate change is making headlines these days and urgent action is needed on several levels ; from public entities, but also the financial sector has a role to play to help finance the transition to a more sustainable development. To focus attention on the subject and get everyone on board, the EU Commission is currently working on concrete measures to shine the spotlight on sustainability in finance.

In the asset management space, the traditional players are jumping on the bandwagon and are beginning to offer ESG (Environmental, Social, Governance) products alongside specialized funds managed by specialized groups. Whereas some years ago strategies were based on exclusions only, positive screening and active management are becoming an integrated part of market practice in sustainable investment funds. Sustainable portfolio managers nowadays embrace ESG analyses and soft factors into investment decisions. This is often paired with ongoing engagement with companies in order to make rounded investment decisions. Furthermore, internal ESG specialists and external ESG data are becoming vital to provide relevant insights to fund managers. Growth rates and the competitive financial performance of sustainable investment products are positive signs that the ESG market has not an ephemeral notion. The market is progressing to include sustainability not just in operations, but also in strategic decision-making.

How close is the industry to seeing ESG become a regulatory requirement ?

The EU Commission has made several legislative proposals to advance sustainable finance by curtailing free riding. The cost-benefit equation must be clarified to market practitioners, as regulations often have a negative connotation. With the retail market being largely untapped, the deployment of standardized ESG information within MiFID II and IDD might lead to a strong boost in demand. In PRIIPs, a level one integration of ESG factors is already foreseen, while the level 2 integration of the ESAs technical specifics is in consultation. A label could be an easy way to integrate ESG information and give confidence to retail investors.

For new asset management adopters, the strong potential for long-run customer acquisition and retention might make up for initial efforts in becoming compliant. Those who already currently factor in sustainability will have a competitive advantage over those who are not yet in the loop.

Will companies soon need to report on their impact on climate change ?

The Technical Expert Group (TEG) on Sustainable Finance set up by the Commission in July 2018 published in January 2019 its first report on companies’ disclosure of climate-related information. The current recommendations allow the Commission to update its non-binding guidelines on non-financial reporting with specific reference to climate-related information, in line with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) established by the Financial Stability Board. These will be aligned with the Commission proposal on a taxonomy, a specific classification of sustainable economic activities. The TEG’s first report lines out that in the future disclosures might not only integrate how climate change might influence the performance of a company, but also the impact of the company itself on climate change. The TEG is now expected to complete its other reports, starting with the climate change taxonomy, carbon benchmarks and green bonds by June 2019.

What role does tech have to play ?

Financial technology and sustainability are two major drivers of change and impact in the financial sector today. FinTech can break new ground in the area of sustainable finance. Our current consumption and way of living are posing new challenges to the planet and people. This presents an opportunity to rethink the way we all do business and make full use of innovative game changers. Already many actors in the tech space are working on solutions in a sustainable mindset, from FinTech to CleanTech responding to existing ESG challenges. Business models focusing on the circular economy and sharing concepts are changing traditional value chains. Digital financial services for the unbanked, for instance, were developed decades ago to advance financial inclusion. The creation of functional and experiential value has now become an imperative to make users regularly deploy inclusive financial services.

One of the biggest challenges in sustainable finance today is the standardization of ESG information and the measurement of impactand additionality assessment. Even though data exists in multiple forms, there are not yet uniform ways to structure and analyze it in a consistent and comparable manner. State-of-the-art technology and consensus on definitions may be a cost-reducing factor for ESG analyses in the future that can give a further boost to the flourishing market. Already promoters are leveraging existing technologies for fund data. Harnessing technology in sustainability and integrating sustainability in technological aspects, that’s the way to go !

Mario Mantrisi, General Manager of LuxFLAG
Julie Didier, Head of Marketing and Communication at LuxFLAG