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INSIGHT: Get ready for the EU Green Taxonomy with Impact Cubed’s Arleta Majoch

“Sustainability creates the opportunity for a lot of beautiful storytelling – imperfect as the taxonomy may be, it addresses a real need to introduce some external guidelines around how far we’re allowed to take that.”

With a projected go-live data of December 2021, there is not a whole lot of time left to prepare for the introduction of the controversial new EU Green Taxonomy, a new regulation designed to hold asset managers to account with regards to sustainable investment practice. With a risk that funds could be labelled as ‘greenwash’ if they fall outside what EU regulators define as acceptable, there is an urgent need to assess and, if necessary, upgrade investment portfolios against the new definitions. Sustainability data specialist and portfolio analysis provider Impact Cubed has created a new green taxonomy checking tool to help asset owners and asset managers check their likely level of compliance against the new regulation. Ethical Intelligence sat down with ARLETA MAJOCH, Product Specialist at Impact Cubed and Partner at its sister firm Auriel Investors, to discuss why data is so central to the sustainability debate – and why we still have a long way to go.

Just how widespread an issue is greenwashing within the industry?
It’s definitely a buzzword right now, everyone is talking about it, but disagreement over definitions and measurement of the sustainability of any investment approach makes this debatable and hard to quanitfy. There is a huge variety of ESG, sustainable and ethical investment approaches, and a million arguments around their validity and how to define them, and there is probably no one answer that is going to solve that problem. Not even the EU taxonomy, as we’re already seeing it be challenged with various open criticisms.

Part of the problem has been that sustainability offers a lot of opportunities for beautiful storytelling, which creates the temptation to benefit from that for marketing without necessarily the capital allocation to go with it. One way to counter this is to create a set of comparable data to measure to what degree we are actually investing in line with sustainability objectives. This is what our core model was designed to do – compare the size of active ESG allocations in portfolio holdings, to show in a very quantitative way how much capital a manager or a particular portfolio is allocating to sustainability characteristics.

We believe that despite all the promises and the headlines, there is not as much capital moving in line with those commitments as one might think. The problem is that if there is misleading communication about different investment products, capital might be misallocated based on that information – leading to a portfolio that is branded as sustainable, but whose active allocation to sustainable solutions is actually very small, almost like the concept of a ‘closet tracker’ transplanted into a sustainability context. If these allocations are quantified and decision making can be based on more objective data, however, then that capital can be redirected to products where it can have a more positive impact. 

Auriel Investors recently published a White Paper measuring the sustainability impact of 25 European ESG funds (shortlisted for the UN PRI Award for ESG Research Report of the Year 2019), which found a significant divergence in how capital was allocated in a sample of funds that on the face of it are marketed in a very similar manner (best-in-class ESG with the same benchmark) – some funds did deliver higher sustainability than a market portfolio, but others came with less overall sustainability characteristics than their mainstream benchmark. Comparing the holdings with benchmark constituents on a set of broadly accepted ESG indicators makes this clearly visible – but the same distinction is usually impossible to make based on only the information issued by the funds themselves.

You can understand the temptation among market participants to slightly oversell their ESG capabilities to keep up with the growing demand from investors. But as the market grows more sophisticated and enters the next stage in its development, shifting more from ESG integration towards impact, the next big question is more specific: ‘What impact does your ESG fund have – and how much exactly?’

What role will data play in driving ESG investment forward?
Data is central to sustainable investment. In investment just like in any other field we need information to make decisions. It’s a big issue for the ESG space, because that information has not always been available, and that is an issue around disclosure in the sense of both quantity and quality. We’ve definitely seen progress on that front, it’s on a continuous upwards trajectory and we’ve raised our ambitions around what coverage we can expect compared to five or ten years ago. But there is a lot of data that is just not accessible, yet, and that needs to change. For example, there are metrics that are just as meaningful as carbon emissions from an environmental perspective, but emissions data is the best we can reliably get our hands on right now, so it automatically becomes an almost singular focus for many investors. There are a lot of different investment and research products being launched in the ESG and impact space, partly because there are a lot of different perspectives as to what constitutes sustainability. In a way, that is healthy in terms of growth and evolution of the space, but on the other hand, too much subjectivity also opens the door to greenwashing – which is why the regulator has felt compelled to step in in the case of the Green Taxonomy. A diversity of opinion and an ongoing nuanced discussion is healthy, but we do also need some overarching central definitions that help keep exploitative behaviours in check.

So tell us about the new product?
Our flagship product, the Portfolio Impact Footprint model, measures the sustainability of a portfolio of listed assets against any comparison set, most commonly an index benchmark. The tool assists investors in measuring and managing the impact of any portfolio in terms of the UN SDGs, and that framework is hugely popular within the investment industry. But we have received a lot of interest from our clients in reporting and even portfolio construction around the EU Green Taxonomy, so we developed this new tool as a kind of early check of what their existing portfolios, or even products in development, will look like through the taxonomy lens. The product works on the basis of breaking down the products and services revenues of underlying portfolio companies, and those underlying revenue streams are then mapped within a framework defined by the EU Green Taxonomy. Because it is automated, it has the capacity to process very diversified portfolios and quantify what percentage of those revenues are likely to qualify or not under the new regulation.

Will the EU taxonomy take over from the SDGs as the industry benchmark?
It’s an interesting question, and one we hear a lot. The thing about the EU taxonomy is that it’s only focused on the environmental aspect, so compared to the SDGs, which allow us to map both environmental and social effects on both the positive and negative side, the new taxonomy is limited only to the green upside. However, a lot of our clients are feeling pressure to shift their attention towards preparing for the EU regulation, because it will be mandatory, whereas there is no actual legal obligation to report on the SDGs, despite their relatively wide adoption by the industry. Any regulatory requirement is going to capture the attention of investors, so that’s an easy explanation for the momentary shift of focus. However, I don’t think the new taxonomy will displace the SDGs altogether. It refers to a much narrower scope of sustainable investing, whereas the SDGs offer a much broader framework on both sides of the coin. Following SDG stats, for example, we are able to quantify how much of a given portfolio is actually exposed to environmentally destructive products and services for industrial activities within that external framework – whereas the Green Taxonomy only focuses on the upside, so it only tells half the story. Both frameworks have a role to play – in our view, the taxonomy will add another layer of insight, and is a framework directly targeted at investment activity, but it certainly should not replace SDG reporting.

What it will also do, however, is add an extra element of pressure, because it is mandatory – and if resources are stretched, that could mean that attention is shifted away from the SGDs in order to focus on taxonomy compliance in the short-term, which carries a downside to it from an overall sustainable investing perspective.

What kind of urgency are we seeing in the market around that compliance?
There is definitely a sense of urgency. The burden and the cost of reporting will depend to some degree on how strictly the taxonomy rules are expected to be adhered to, but the upfront effort will certainly be high for many investors regardless. It’s also a relatively short timeline for phasing in the taxonomy by institutional investing standards – I don’t think investors are necessarily going to be trading in anticipation or making any major changes to their portfolios, but they simply want to be as prepared as possible.

The main purpose of the pre-screening tool we launched this week is to give investors an indication of what their portfolios will look like through the green economy lens, and provide a roadmap for future activity, rather than to provide any kind of reporting tool just yet under a framework that is still in draft form. But the reporting element will naturally come in further down the line. 

So what can we expect for 2020?
This year seems to be shaping up to be a year for climate. We are seeing a lot of activity around that question, and a lot of exploration around the impact of investing on climate targets. There are big players moving into the space that have been catalysed by the climate issue especially, which makes us cautiously optimistic, but there is both more that needs to be happening on climate alone, as well as a huge variety of sustainability issues that we need to be thinking about in tandem. Look no further than the UN SDGs for an overview, with many interdependencies between individual aspects, such as gender equality and carbon, or animal agriculture linking to carbon emissions and deforestation, as well as public health, as well as food security for a growing global population etc.

There is a disconnect between the scale and ubiquity of verbal commitments and media announcements, and the actual amount of capital that is shifting in line with them. It simply is not keeping pace, and that is frustrating. We are moving forward, but not as quickly as we need to be.

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