Humanitarian scandals dating back to the 19th century led to the creation of ecolabels, which vouch for a product or service’s environmental credentials. Lairab Shahid examines the EU Ecolabel for Retail Financial Products, now under development.
During the 19th century, the poor living and working conditions that accompanied rapid industrialisation and urbanisation led activists to raise their voices against human and resource exploitation. That is when the debate about sustainability began.
At different times, active campaigns for social and environmental awareness have compelled authorities, including business corporations, to improve conditions for people and the environment. Among several initiatives in the 20th century, ecolabels were introduced to certify the environmental performance of a specific product or service.
Today, they are found globally and are important not only to climate-conscious consumers but to clients of the fund management industry. Governments and regulatory bodies are still working to develop ecolabels for investment products as they chart a pathway to greener economies.
Laying the groundwork
Sustainability standards are seen as one of the main prerequisites for consumers and investors at the moment. Such standards date back to the late 19th century, when injunctions for ethical production within Europe surfaced.
Europe’s foreign colonies suffered decades of exploitation before the horrendous working conditions in these areas were known to the public at large. The first Europeans to develop this social awareness were the Dutch. Books such as Max Havelaar: Or the Coffee Auctions of the Dutch Trading Empire – the story of a guilt-ridden civil servant in colonial Java, published in 1860 – prompted several social endeavours by the Netherlands government for the colonies, including education, banking and infrastructure.
Before much could be accomplished, however, historians say the two world wars and the economic depression of the 1930s reversed what little had been done in Europe. Arguably, the debate about sustainability standards did not resurface until the 1980s, a period when the world opened up to free, liberal trade. The vision of the time was to set up factories in the ‘global South’ (developing countries) and then trade finished goods to the global North (the developed, Western nations).
Activists and environmentalists were wary of free trade’s growing footprint, pointing to environmental and social harms. However, a solution seemed to appear in the form of sustainability standards and ecolabels.
Our Common FutureA UN report called ‘Our Common Future’, published in 1987, suggested that everyone – not just environmentalists – had a role to play in solving these environmental issues.
The notion of sustainability standards – outlining how a product is manufactured while specifying ways to minimise any related environmental or social damage – ties in with this. Producers who comply with such standards are granted the right to label their products appropriately.
In the 1980s and 90s, for example, when deforestation became a major issue, products related to forests were able to make use of these.
“Europe’s foreign colonies suffered decades of exploitation before the horrendous working conditions in these areas were known to the public at large. The first Europeans to develop this social awareness were the Dutch.”
The first ecolabel was the Blue Angel, released by the German government in 1978. Awarded by an independent panel of stakeholders, such as environmental experts, trade union representatives and non-governmental organisations, it is given to products and services that are deemed to be environmentally friendly.
In the years that followed, most industrialised countries developed similar ecolabelling schemes. These flourished in the 1990s and received a global endorsement from the United Nations Conference on Environment and Development, known as the ‘Earth Summit’, in 1992.
As the Scottish marine scientist Tavis Potts wrote in a research paper on ecolabels, world leaders at the conference – held in Rio de Janeiro, Brazil – agreed to “encourage expansion of environmentally related product information programmes designed to assist consumers to make informed choices”.
For several decades now, standards and ecolabels have been useful tools for reaching environmentally conscious consumers in global markets. They have also been embraced by market regulators and governments, notably in the European Union.
European initiativesThe EU established its official ecolabel for environmental excellence in 1992. This EU Ecolabel, recognised worldwide, certifies products with a guaranteed, verified low ecological impact.
Throughout their life cycle – from raw material extraction through to production, distribution and disposal – goods and services must satisfy high environmental standards to meet its requirements.
Currently, in light of Europe’s vast and expanded investment industry, the EU is developing the EU Ecolabel for Retail Financial Products, based on the European Commission’s recently adopted Sustainable Finance Action Plan.
This is intended to help retail investors make informed decisions on the sustainability features of investment products and marks the European Commission’s first attempt to develop an EU-wide label for green retail investment products.
It would apply to various retail financial products, including retail equity, bond and mixed investment funds, insurance-based investment products, and fixed-term and savings deposits.
The ecolabel is a voluntary scheme under development that will require compliance with six main criteria. The European Securities and Markets Authority (Esma) – that is, the regulator – put the first three quantitative thresholds of the criteria to the test, namely investments in environmentally sustainable economic activities, exclusions based on environmental aspects, and exclusions based on social factors and governance practices.
Esma’s detailed study of the ecolabel criteria was designed to see how they would work. Testing three criteria on a sample of 3,000 sustainability-oriented Ucits equity funds with €1 trillion of assets under management, it found that only 16 funds (0.5% of the sample) met the proposed minimum portfolio ‘greenness’ threshold and exclusion requirements.
Eco-friendly criteriaThe first criterion was portfolio greenness. Here, Esma found that only 26 sustainability-oriented funds – fewer than one out of every 100 tested – had a ratio above the suggested ecolabel threshold of 50%, measured by alignment with the EU green taxonomy (a classification system for sustainable activities). These funds include those described in Articles 8 and 9 of the Sustainable Finance Disclosure Regulation.
Reliance on the taxonomy created many challenges for firms, noted Esma, adding that the taxonomy alignment of investment funds needed to be higher. In 2020, the estimated alignment of EU-domiciled funds with the EU taxonomy was 1.4%, according to the regulator, while studies by the UN found that even ESG specialist firms failed to achieve high taxonomy-alignment ratios.
The second and third criteria focused on how funds excluded investments based on environmental and social grounds. Esma tested four types of exclusions: fossil fuels, tobacco, pesticides and controversial weapons. Of these, the most demanding requirement for sustainability-oriented funds is the 5% limit on fossil fuel activities.
Exclusions relating to pesticides, tobacco and controversial weapons are much less challenging. As a consequence, 78% and 85% of funds meet the corresponding requirements for environmental and social exclusions, respectively.
The result of combining the four exclusion requirements was that 1,472 funds, or 48% of the sample, were eligible for the ecolabel.
“Many might find it encouraging that experts from around the world, working with political institutions, are making keen efforts to achieve sustainability goals and devise strategies that favour the environment.”
Esma found that 16 funds fulfilled criteria one to three when combining the exclusions with the minimum portfolio greenness requirements. The fossil fuel limit disqualifies nine out of the 26 funds above the greenness threshold, and tobacco disqualifies one.
Looser requirements would raise the potential volumes of green finance channelled through eligible funds. Esma’s view is that this could damage the ecolabel’s credibility, however. Achieving a satisfactory balance will require careful calibration of the criteria.
Esma’s analysis demonstrates that, all things being equal, a higher greenness threshold reduces the marginal impact of a tighter fossil-fuel exposure limit, and looser fossil-fuel restrictions increase the marginal impact of a higher greenness threshold.
The study emphasised that interactions between different ecolabel requirements should lead to a higher offering of ecolabel products. This could draw in a larger number of investors and financing volumes, given that such actions do not harm the ecolabel’s credibility, Esma concluded.
What’s next?What started as a consciousness-raising exercise about planetary resources and the treatment of human beings has become a well-integrated system of labelling around the world.
Where the EU ecolabel for retail financial products could make it easier for sustainability-minded investors to choose their preferred products, stringent requirements may deter asset managers from opting for a voluntary ecolabel. That said, the requirements should be practical enough to draw more fund managers into employing voluntary ecolabels without undermining the label’s credibility.
Finding solutions to the world’s complex environmental and social challenges may be more difficult, with no one criteria providing across-the-board solutions.
However, many might find it encouraging that experts from around the world, working with political institutions, are making keen efforts to achieve sustainability goals and devise strategies that favour the environment.
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