The EU’s sustainable finance action plan will increase operating costs by more than €20 billion, says Dr Andy Sloan, founder of Channel Islands-based think-tank, the ISICI.
With the ESG marketing juggernaut in full swing, it feels impolite and almost rude to raise concerns publicly about regulatory costs associated with sustainable finance. Yet the recent International Sustainability Institute Channel Islands (ISICI) paper on the costs of the EU’s approach to sustainable finance regulation could not have been timelier.
Not only does it coincide with the Sustainable Finance Expert Group’s call to expand and revise the EU Taxonomy, but our paper also comes after a decade where regulatory costs in the EU have risen significantly, over and above the revised capital requirements introduced in the name of financial stability.
At ISICI, we believe such concerns were at the root of UK thinking in its decision to diverge from the EU’s technical rulebook.
Given the speed of transformation of the investment landscape - with US research firm Opimas finding that the value of global assets applying environmental, social and governance data to drive investment decisions doubled in the four years to 2020, to $40.5 trillion, together with the huge advisory industry that has appeared almost overnight - there are major concerns about ‘green-washing’ in the sector.
As Morningstar put it recently, “asset managers continue to repurpose and rebrand conventional [fund] products into sustainable offerings”.
It is not surprising that regulators have sought to act. But we have significant concerns with the costs of the EU’s regulatory approach to sustainable finance.
We do not believe the burden or the benefits of this layer of ESG-type reporting requirements have ever been properly considered.
No proper impact assessment
In fact, no proper economic impact assessment was ever produced. Instead, an a priori assumption that harmonisation creates efficiency, combined with the harmonisation mandate under the EU’s Capital Markets Union, was relied upon to justify the introduction of the Sustainable Finance Disclosure Regulation (SFDR).
We estimate that the current regime will increase the operating costs by more than €20 billion, consuming as much as €2.5 trillion in capital by 2050, the date when net zero is targeted. This is capital that could be more usefully deployed to climate finance.
The investment sector has still to fully absorb the significantly higher costs of the increased regulatory burden of the last decade and is now having to come to terms with a very different and inflationary investment outlook.
We do believe that consideration of ESG-type risks is a practice to be encouraged, particularly if such risks may have a material impact on future pricing.
Many studies suggest a potentially positive relationship between consideration of such risks and returns. Yet few, if any, find proven causality.
Our explanatory narrative is that managers that take a broader assessment of risk, ceteris paribis, tend to generally achieve better returns.
This would suggest that investors would be advised to seek out such managers, but it does not provide compelling evidence to prescribe by legislation which particular ‘sustainability risks’ should be assessed by such managers, nor indeed how such an esoteric objective must be measured.
Our view is that there is a significant difference between the rationale for mandatory risk-related disclosures of Task Force on Climate-related Financial Disclosures (TCFD) reporting and the rationale for broader ESG-type reporting – a distinction that is rarely presented or discussed.
The policy mandate for TCFD is derived from the Financial Stability Board and the G20, with the policy objective being the IPCC targets, as agreed under global legal agreements arrived during the COP process.
We also believe that TCFD reporting can serve as a sensible cost-effective proxy for alignment with sustainability generally, with much less complexity.
We maintain that expensive requirements for ESG-type reporting of variables of ambiguous value risks undermining the cause of sustainable finance.
Our opinion is that this justifies the UK’s divergent approach from the EU in sustainable finance.Focussing on core TCFD disclosures is in our view a more proportionate and cost-effective approach. One we also believe is also more consistent with policy goals and regulatory mandates. We encourage this route.
Dr Andy Sloan is an economist, strategist & non-executive director. He is also founder of the International Sustainability Institute Channel Islands. To read the full paper of the International Sustainability Institute Channel Islands paper ‘A €2.5trn question? The Costs of the EU’s sustainable finance regulations’ go to www.isici.org/research.
© 2022 funds europe