Who sets the moral benchmarks for socially responsible investment?

For green finance to do its thing – that is, drive environmentally friendly activities – investors first have to trust it.

For European investors, the information provided in fund prospectuses under Sustainable Finance Disclosures Regulation (SFDR) provides a baseline level of environmental, social and governance disclosure, says Áine Ní Riain, senior associate at corporate law firm K&L Gates.

“The SFDR requires transparency to investors on the adverse impacts that the fund’s investments have on the environment, climate and society,” she adds. “For funds with some level of sustainability-related ambition, they have to provide investors with a certain amount of information and data before they accept subscriptions from investors.

“In that sense, it is a ‘put your money where your mouth is’ regime, in that, if you suggest to an investor that you’re doing some good, you need to back that up with information on what exactly it is you’re doing.”

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There are different levels of disclosure and requirements, depending on what you are purporting to do.

“An Article 9 fund, which is one that has sustainable investment or a reduction in carbon emissions as its objective, has rules relating to its portfolio composition and must provide a high level of data in its reports. These are often called ‘dark green’ funds, and rightly so,” says Ní Riain.

On the other hand, an Article 8 fund promotes environmental or social characteristics, and what it is required to disclose and report upon depends on what it seeks to achieve, Ní Riain explains.

“The interesting thing is, as with most products, the first thing a consumer has to inform them is a product’s label,” she adds. “The SFDR was never intended to be a labelling regime but, for better or worse, this has become the case.”

For individual companies, we are entering a period of greater than ever access to sustainability data. The Corporate Sustainability Reporting Directive (CSRD), which came into force last year, will see its first set of reports produced next year.

“The directive, which is being implemented in phases, depending on companies’ and groups’ sizes and roles in the market, introduces mandatory sustainability reporting mainly for large or listed companies with limited liability, including EU companies and certain non-EU companies,” says Ní Riain.

Assessing the data is vital for financial advisers too. “We believe it is very important to measure and monitor the impact of our sustainable portfolios against the global challenges we all face. We also want to assess our objective of investing in companies and funds that have a positive societal or environmental impact with meaningful context,” says Conal Cremen, chartered financial analyst with RBC Brewin Dolphin.

To independently assess its success in these areas, the firm uses MSCI, a third-party ratings agency.

“We provide reports on the resilience of our portfolios to long-term ESG risk, the greenhouse gas emissions of our portfolio and how aligned our portfolio is to the United Nations Sustainability Development Goals,” Cremin adds.

Another key responsibility that needs to be monitored is stewardship. “We believe fund managers that act as responsible owners, or good stewards, of our clients’ assets, can help maximise positive outcomes by encouraging better behaviour from investee companies,” says Cremen.

Under a new agreement reached in February, the EU will issue its first set of rules regulating ESG ratings of corporate sustainability activities, which will help, says Eileen Rowsome, director, responsible investment, at Davy Private Clients.

The move is designed to abate the risk of greenwashing, where companies over-egg their sustainability credentials. Under the new rules, ESG ratings providers, which were previously unregulated, will have to be authorised by ESMA, the European Securities and Markets Authority.

“ESMA would provide guidance as to best practice for financial services firms but ultimately it is up to the Central Bank of Ireland – or other regulator in another EU country – to ensure appropriate implementation,” Rowsome points out.

The move will give everyone a much clearer sense of what good actually looks like.

“Part of the premise of the SFDR and the EU taxonomy is to provide clarity to the investor as to what is a sustainable investment and to have an objective standard,” says Rowsome. “That’s because, while ratings agencies produce their assessment of good environmental, social and governance practice, and it all feeds up into an overall score rating, the individual had little clarity as to what determines the ultimate score.”

“What is material from a rating-agency perspective isn’t clear if it’s material in a moral sense or material in a financial sense, so I think that could be really helpful for investors.”

All these moves are bringing greater transparency. “If we had had this conversation a decade ago, it would have been about choices, about the values of organisations and financial firms, and whether they chose to get involved in sustainable finance and investments. Those days are now behind us,” says Rahim O’Neill, deputy director of Ibec’s Financial Services Ireland.

“Now, within the EU, there is an infrastructure in place, starting with the Green New Deal, working its way down through the likes of the taxonomy and the SFDR, down to the CSRD – a whole hierarchy of rules and regulations to determine what is sustainable, green or socially responsible.”

Indeed, the biggest confusion now might just be all the acronyms. But each represents a part of a jigsaw which has been well thought through and links together perfectly to provide as clear a picture possible to investors, says O’Neill.

The point of it all is to normalise sustainability characteristics in accordance with standard business practices, he adds, including penalties, just as there are where a company misleads investors in relation to its financials.

It’s all to the good of investors – and the planet. “Any company’s sustainability report will give individual investors a lot more information about a company than at any point in history,” says O’Neill.