Funds Europe – How are firms approaching SFDR compliance and what steps are they taking to meet regulatory requirements?
Mahmood – If you look at the universe of Europe-domiciled funds and fund managers in general you’ll find most of them are now reporting on not only the SFDR Articles – Article 8, 9 or 6 – but also on the principal adverse indicators at fund level as well. Some have gone further to report the additional indicators, too. Most European asset managers and fund managers in general have responded well to the regulations and generally welcome them.
Alexeyev – SFDR has increased the clarity of disclosure and the extent of disclosure as well. You have much more information coming from asset management companies on strategies that we previously suspected were ESG, but now we can clearly see how they are managing that process. What’s interesting is that the investment universe itself has expanded dramatically since SFDR came online: the ESG universe in Europe increased by about €1 trillion in assets under management (AuM). People are asking questions about what’s driving that.
Has the investment process or shareholder engagement process really been transformed or are they just being more introspective about how they go about implementing ESG? Most firms took a very hard look at what they were doing and decided, ‘Well, this is something that we need to do better,’ and SFDR gave them that opportunity to refine their approach.
Funds Europe – In practical terms, what does achieving net zero require in terms of transforming investee companies?
Firth – In our view, achieving net zero requires long-term, deep engagement with investee companies to enact meaningful change to reduce emissions, such as by encouraging them to set emissions targets and commit to regular measurements and assessment of their progress. They must be held accountable and made to back up their words with concrete actions. We believe actively engaging with all companies is critical to the energy transition. It is our duty as a responsible investor to secure real-world change that will ultimately bring about a lower-carbon portfolio, rather than simply divesting or offsetting. It is easy to dismiss high-carbon companies as high-risk, too damaging to the environment, and divest. However, doing so risks oversimplifying what is a more nuanced and complicated matter.
Relying solely on offsetting only works to adjust the perception of progress at a portfolio level and does little to combat the real-world impact of climate change.
Barrie – The theory of change behind net-zero funds has to be clear because it’s possible to achieve more than a 50% reduction in carbon intensity just by cutting out oil, gas and utilities. Reducing carbon intensity is a good thing, but if you avoid those sectors, you are selling them to someone else and not necessarily achieving or influencing the transition. So, while divestment sends an important message, it is not necessarily the most effective tool to encourage the transition, and we should be aware of carbon-washing that’s not connected to real economy changes.
We have made sure that our passive investments follow an index that is about the transition. The index achieves a reduction in carbon intensity but rewards and penalises on the basis of companies’ forward-looking transition plans, so it is not just about avoidance. If a company is assessed as not aligned with a transition, they get a ‘zero’ weighting, and if their carbon performance is aligned with the 2 degrees and below 2-degree scenarios, they receive a 150% or even 200% overweighting respectively. We’ve allocated about €800 million to the FTSE TPI Climate Transition Index which, as I mentioned, is based on publicly available and academically credible climate transition scores.
Gloak – From an index perspective, the ETF market’s sustainable indexes have come a long way in the last 12 months. There are now 42 climate ETFs in Europe with just under $8 billion in AuM. The previous year it was half that, with 22 funds and just under $2 billion AuM, according to BlackRock research at August 2021. Index providers have gone early on climate ETFs, and they’ve looked to offer strategies that align to the EU’s Paris benchmark, for example, so a 50% carbon-intensity reduction.
Providers and asset managers have got these funds out early so that hopefully, with momentum provided by COP26, there will be a set of building blocks out there for clients come December or January.
Mahmood – Regardless of whether it’s index-based or more active, engagement is one of the key steps, but transforming investee companies isn’t just a one-way street. Meaningful change through meaningful engagement is reliant on meaningful data, so investors need consistent and credible information on an organisation’s climate commitments to make decisions, and they increasingly expect climate commitments that are science-based and linked to the organisation’s core business strategy and decision-making.
They require that climate-driven risks are presented clearly and that the company’s business models and strategy accounts for these risks.
They also require comprehensive plans and processes to respond to those risks to achieve stated target greenhouse gas emission reductions or whatever it might be in line with the objectives of the Paris Agreement or any other regulatory development.
Transparency and consistent reporting in companies is crucial, as well as overall commitment, narrative and financial statements as well as non-financial disclosures. Collectively all this can help investors make informed decisions on whether or not they’re on trajectory when it comes to transforming investee companies, and transparent vehicles such as index-based approaches and ETFs help in this regard in terms of daily disclosures and having all that data available for every single company on a continuous basis.
Barrie – I agree that good data is really important, but another tool for making good decisions is having a good standard or benchmark. Climate Action 100+ has been working hard on creating a relatively holistic net-zero investment benchmark. It’s not just about emissions intensity and good-quality ESG data, but as a benchmark, it can help us answer the question what is good enough (for now!). An oil and gas net-zero standard was launched by IIGCC [Institutional Investors Group on Climate Change] in September, and there’s the Climate Action 100+ net-zero benchmark which was released earlier in the year. Useful tools.
Alexeyev – If we look at European institutional investors, 75% of them have a GHG emissions reduction target and 40% have set a net-zero goal. But what does this mean? While some asset managers may be prepared to help them, others must move faster. There is a lot of catching up to do in terms of building capabilities, developing climate-transition portfolio solutions, and doing it in an agile way with constant innovation and iteration to make sure we’re going in the right direction. The starting point is always understanding investor needs, but asset managers also have an opportunity to act as a thought leader and a thought partner to help institutional investors with best practices around achieving net zero.
If the corporate issuer sector lags in reducing emissions, there’ll be an interesting situation at some point in time where there may be constraints on investment choices for asset managers of institutional investors, and they need to be prepared to manage that. Collaborative engagement is extraordinarily important, along with improved proxy voting, followed by working closely with initiatives such as the Net Zero Asset Managers Initiative, the Net-Zero Asset Owner Alliance, as well as the Paris Aligned Investment Initiative.