Regulators in Europe, South Africa, China and Malaysia are increasingly turning their attention to taxonomies. The PRI considers taxonomies a generational shift in how we think about sustainability issues. Taxonomies are here to stay.

Convened by the PRI, over 40 investors have implemented Europe’s taxonomy in anticipation of incoming European regulation. The progress made by the group is encouraging, and we have now published the first ever comprehensive set of case studies on how to use the EU taxonomy.

We started by implementing the EU taxonomy as it is the most advanced:

It has regulatory approval. By the end of 2021, investors that market their funds as environmentally sustainable will be required to disclose against the taxonomy.
The framework is clear. Environmental activities must make a substantial contribution to climate mitigation or climate adaptation, must do no significant harm to other environmental goals and must meet minimum safeguards.
It is the most developed. The proposed economic activities and performance measures cover 94 per cent of Europe’s carbon emissions and follows substantial research by the EU Technical Expert Group (TEG).

The case studies cover most major asset classes, geographies (including global funds) and investment styles. We hope that by sharing the main findings with financial market participants and policymakers, the case studies will support confidence, and greater ease, in the implementation of the taxonomy.

In their case studies, investors have addressed multiple questions, including:

How to measure taxonomy-eligible investments
How to compare sustainability performance with taxonomy thresholds
How to undertake analysis on Do No Significant Harm (DNSH) and Minimum Social Safeguards requirements
What were the data gaps
What were the results

It’s worth noting that all investors started work on their case studies before the taxonomy had formally been made law. In doing so, they have been working at the cutting edge of policy design. But it’s also clear that to optimise taxonomy applicability, policymakers and regulators need to do more. The PRI recommends EU policymakers:

Develop disclosure frameworks to make sure that investors have the right data, at the right granularity, for the right issuers to undertake taxonomy analysis.
Provide more guidance and clarity about supervisory expectations for taxonomy disclosures.
Continue with ongoing development of the taxonomy and work to harmonise it with international efforts.

Among the list of case studies is Neuberger Berman (NB). NB implemented the taxonomy in an actively managed US Equity Impact portfolio, comprising 41 companies and identified 12 of 41 companies that were taxonomy eligible. In other words, the 12 companies undertook some economic activities consistent with taxonomy criteria.

To test whether the company met DNSH criteria, NB undertook primary research supported by third party data and created an internal rating system of green, yellow and red based on levels of compliance. For social safeguards, they undertook three sets of assessment: company policies, past instances of complaints or controversies, and third-party data.

While not all case studies published total portfolio alignment, NB did. NB assessed company turnover in determining 20% taxonomy alignment. A further 1% was potentially aligned, but company disclosure was incomplete. A further 3 per cent is potentially eligible as the taxonomy extends to the further four environmental objectives.

In addition, Axa implemented the taxonomy in a global fund of both equities and corporate bonds. The DNSH criteria were assessed through their minimum ESG standards, which excludes companies with UN Global Compact (UNGC) violations and companies of poor ESG quality. For social safeguards, Axa undertook their own analysis, which was supplemented by third party data.

They also used third party data to split revenues, and additional third-party data to assess future green revenues.

Impax’s case study is a little different, undertaking a deep dive of five companies in Europe and China to assess taxonomy usability.

First, Impax mapped their own stock classification against the taxonomy, supplemented with third-party data. To assess DNSH criteria, they used a company-level proxy test, backed by data from third parties. For social safeguards, Impax analysed companies for social and governance impact, across four sub-pillars: customers, human rights and community, labour rights, and corporate governance.

Impax then assessed the latest publicly disclosed revenue data to determine taxonomy alignment, splitting revenues based on assumptions where the data was incomplete.

The case studies are a good demonstration to the market of the practical application of the EU taxonomy which we hope will inform policymakers and investors alike.

It’s also important to recognise that the investors that prepared case studies committed to doing so prior to the publication of the EU Commission’s delegated acts which formalises the environmentally sustainable activities and performance measures (due later this year), prior to publication of the Technical Expert Group (TEG) report, and in some cases, prior to the political agreement of the taxonomy regulation. And did so during a global pandemic!

We consider this real leadership, and we thank all the investors involved.

You can read the current list of case studies here.

To read PRI’s analysis and policy recommendations, click here.

Will Martindale is the head of policy and research at PRI.

How to integrate the SDGs

Integrating the SDGs involves analysing investee companies’ core business, the products and services they sell, and mapping that to the SDGs. Two investors, APG and Schroders, outline the indepth process.

APG, the giant Dutch asset manager, began integrating the SDGs in 2015 at the behest of its major client pension fund ABP whose beneficiaries work in the government and education sectors.

“We set a target to contribute €58 billion to the SDGs by 2020,” said Claudia Kruse, managing director global responsible investment and governance, APG. Speaking at Sustainability Digital she said because APG was already an active owner with ESG integrated across the portfolio, it needed to ensure a new strategy to align with the SDGs was “distinct.”

Working with fellow Dutch asset manager PGGM, the investors began to look at investee companies’ core business and the amount they contributed to the SDGs as well as analysing risk return targets.

“We quickly realised we couldn’t do this without research and that we needed a technological solution,” Kruse told delegates. Five years on, APG together with a cohort of other investors has launched an AI driven SDG platform providing a standard for asset owners around SDG corporate disclosure.

She also espoused the importance of communication and transparency. This includes detailing what is and isn’t contributing to solving the SDGs in APG’s reporting processes and seeking stakeholder feedback “to become a better investor.” She also pointed to more pension funds engaging with beneficiaries in another sign of “the growing credibility of the financial sector.”

It was a point fellow panellist Andy Howard, head of responsible investment at Schroders reiterated by explaining to delegates that the asset manager’s transparent communication must detail what it is trying to achieve. In a process grounded in measurement this transparency marks the industry’s transitions from “story-telling to demonstration.”

The challenges outlined in the 17 SDGs have built up over decades and were here before the pandemic, said Howard. However, he noted that the pandemic has catalysed the need for action and could trigger meaningful progress.

“The SDGs have given us a path out,” he said, also noting that countries suffering challenges flagged in the SDGs like inequality and social tension have particularly suffered from COVID-19.

Schroders’ Howard noted that there is more data available around climate than other SDGs meaning climate change gets most attention. However, he noted that the pandemic has shone the light on SDGs around healthcare and discrimination. He also told delegates that the practical process of aligning capital to SDGs is challenging.

“It’s an important goal but practically speaking difficult,” he said.

The SDGs are often characterised as an individual fund or strategy yet the real challenge lies assessing how every company contributes to the SDGs rather than a small percentage of corporates.

It involves looking at the sweeping array of products and services companies sell, and mapping them to the SDGs in a process that has required developing a bespoke framework because there is nothing “off the shelf.”

He added that the asset manager doesn’t see SDG integration as a philanthropic endeavour but a reflection of how the world is changing.

“This is an investment question; where do we deploy capital and ensure the capital we deploy is aligned,” he said.

Panellists also offered insight into how investors should pick which SDGs to integrate. Howard noted that the burden of some SDGs falls more on policy makers and governments than investors when the focus is on partnerships and the policy agenda. However, others fall on the private sector.

He told delegates that choosing which SDGs to integrate isn’t about which ones are more important or likely, but it is about what role private sector investors can play in trying to solve them.

Howard said that some parts of the capital markets will find it difficult to align the SDGs and industries will similarly struggle to transition to sustainable outcomes. There are some industries where change can happen, but it requires real effort and makes engagement critical, he said.

He noted that the world is changing and concluded that SDG alignment is turning into a robust and detailed decision making process across Schroders.

“It is an obvious step for an organisation like ours to think about the world in this way,” he concluded.

For all the conference sessions, stories and white papers visit the Sustainability content hub here.

Coca-Cola and Robeco talk engagement

Engagement isn’t necessarily based on conflict. Robeco’s engagement with Coca-Cola is welcomed by the drinks giant and is helping drive long-term growth.

A combination of investor and consumer pressure has helped drive change at Coca-Cola around single use plastic, water use and the sugar content of its products, said Beatriz Perez, chief sustainability officer at Coca-Cola.

In a panel session at Sustainability Digital discussing how investors and corporates engage speaking alongside Robeco’s Peter van der Werf, team lead engagement, active ownership, Perez told delegates that she welcomed the positive “tension” and pressure for change investor relationships have ushered in at the company, saying it is helping drive long-term growth.

Perez told delegates that continuing to deliver sustainability targets through COVID-19 has been a hallmark of recent strategy. On one hand the pandemic has highlighted the importance of sustainability initiatives at the company like its ambition to be water neutral in light of the new importance of safe water supplies for hand washing. Yet the pandemic has also made reaching sustainability targets challenging, like the need to protect workers in the company’s bottle recycling plants.

“If sustainability is core to your strategy you have to continue to keep it in the business – you have to pivot,” she told delegates.

Working with investors to integrate sustainability has created a positive tension that has pushed the company to “think ahead,” she said. Coca-Cola has put in place a strategic framework and goals around sustainable agriculture and packaging with embedded targets. She also noted that integrating sustainability has changed over the last 10 years. Back then the focus was on risk mitigation. Now it is seen as “fundamental to achieving growth,” comprising measuring and tracking.

Pressure for change has also come from consumers, she said. She also noted that the company could have picked “hundreds” of areas in which to focus. Instead it chose areas where it got the best leverage for communities, staying ultra-focused on delivering results.

It’s important to have investment partners challenge us, she said, adding that investors “see things” that present a risk to the business. For example, Coca-Cola’s ‘World Without Waste’ initiative which aims to make its packaging 100 per cent recyclable by 2025 and use 50 per cent recycled material in bottles and cans by 2030, came out of dialogue with investors.

“They said you have to get “more serious” about plastic or it could be detrimental,” she recalled, adding that it has led the company to focus on the circular economy and how that works across the business.

Robeco is also engaging with the drinks company on nutrition.

“It’s been a big focus in the last three years,” van der Werf said.

The investment manager asked the company to find its “North Star” and look to the SDGs to inform a strategy that would better serve consumers. At the same time, consumers were also asking the company for similar solutions, Perez said.

“We changed and shifted strategy to deliver what consumers wanted.”

Cue a reset for the company whereby Coca-Cola signed up to the WTO guidelines on health – a move van der Werf described as crucial because it is a gold standard – and it became a total beverage company formulating new, low sugar recipes and other initiatives like the mini can.

“We took sugar out of the total portfolio and offered new brands,” said Perez.

She also detailed how sustainability strategies intertwined. For example, working on waste reduction required close partnerships based on trust and confidence garnered from the company’s progress in other areas of sustainability. Elsewhere, getting the packaging right meant reducing the carbon footprint of the company.

“These are interconnected parts of the business,” she said.

Robeco’s van der Werf said integrating sustainability meant delivering a broader set of opportunities to consumers. He also noted that investors’ role is to hasten progress and accelerate change where possible. Advocating the circular economy and supporting recycling infrastructure has been a particular focus, he said. He estimated it takes around three years to build a relationship that can “drive to the next level” and that engagement meant being in it “for the long haul.”

Perez also noted how partnerships help drive the pace of change, and scale. Targets and compensation also spur progress, she noted.

She added that solutions differ across geographies – water use issues are different in Kenya and the US for example – and local government’s ability to provide key infrastructure is also crucial in the company’s ability to deliver on societal and business objectives.

Perez said that she welcomed more challenging questions from investors, and the increased pressure for change.

“When we first started to get calls from investor relations and heard that investors wanted this conversation, I cheered,” she said.

She also noted that in the early years, not all investors were engaged or interested, and that sustainability wasn’t viewed by investors as a “discipline.”

Changes over the years include common definitions and industry alignment, and better data. In another aside, she noted that the once pervasive idea that consumers would pay more for sustainability is long outdated. She said now consumers expect sustainability.

To hear more about the importance of engagement listen to the conversation between Peter van der Werf and Amanda White in the podcast, Sustainability in a time of crisis.

For all the conference sessions, stories and white papers visit the Sustainability content hub here.

Nordhaus calls for carbon tax

International negotiations like the Paris Agreement no longer work. The world needs a new framework supporting a carbon tax with both carrots and sticks to encourage participation, says William Nordhaus, Sterling Professor of Economics, Yale University and 2018 Nobel Prize winner in Economics.

Carbon emissions will never slow with the current voluntary system and the world needs a new framework where polluters pay, according to William Nordhaus the Sterling Professor of Economics at Yale University and the 2018 Nobel Prize winner in Economics.

Speaking at Sustainability Digital, Nordhaus set the scene for delegates by illustrating how carbon emissions have continued to rise despite international coordination and progress in science.

“We are not going to get anywhere near the targets if we go along this path,” he said, adding that the policy focus to slow climate change shows that unregulated markets fail.

“It’s failed because carbon has a zero price and this is wrong. The most important step to slowing climate change is to price emissions.”

Nordhaus added that Yale has worked on modelling that recommends a carbon price of $40 a tonne, ramping up sharply over time.

“We focus on different mechanisms, and there are only two possible mechanisms that will get the price of carbon up: one is a cap and trade system, and the other is a carbon tax on emissions.”

In stark contrast to what the price should be, the World Bank currently estimates a carbon price of under $2 a tonne.

“It’s basically zero,” said Nordhaus, adding that given the price is so low, it’s no big surprise emissions are continuing upwards.

Nordhaus told delegates that following the path of international negotiations would not deliver cuts in emissions. Charting back through the decades from Kyoto to Copenhagen, and more recently the Paris Agreement he said none of the agreements have delivered lower emissions.

“The reality is these policies are not effective in slowing the trajectory of climate change.”

Acknowledging that international agreements are “one of the most difficult things to do,” he said history was littered with failed agreements. Quoting Roosevelt, he said voluntary international agreements put countries in a position where they talk, but there is no stick.

He added that the Paris Agreement is “nowhere near” strong enough to get to 2 degrees, even assuming it is met by countries which have set targets. The problem lies in that the agreement is voluntary and is in effect all carrot and no stick.

“This is the reason there has not been a substantial impact on emissions,” he said.

Another approach is to introduce a stick via a climate compact that penalises polluters. Nordhaus called for a climate treaty that includes carrots and sticks so that participation holds benefits for those who take part and costs for those that don’t. Explaining the idea further, he said a coalition of nations should commit to significant reductions in emissions along with mechanisms to penalise countries that don’t participate. The climate compact could comprise a domestic floor for countries who participate with carbon pricing of around $40-$80 dollars per ton. However, non-participants would face penalising tariffs on their imports creating a strong incentive to join the compact.

Nordhaus said that the framework didn’t’ detail specific technologies, rather it designed a landscape to move to a low carbon economy.

He said that by setting a carbon price, consumers would consume more low carbon products and it would herald the birth of many more low carbon technologies.

Rather than living in a “tweaked” world, investors would find wholly new technologies to invest in as pricing fired up innovation.

Acknowledging it was radical, he said that no other blueprint holds the promise of strong international action. Noting that the world was at “square zero” because of international policy, he said voluntary agreements needed to go.

Nordhaus also urged delegates to push companies to follow a policy of “no regrets.”

Arguing that companies can reduce their carbon footprint significantly and at a low cost though fairly straightforward initiatives, he urged more corporates to take action now.

“It is possible to take big steps at a low cost,” he said. “Companies should look at a no regrets policy to improve their footprint.”

He added that energy companies particularly, need to step up and behave like responsible citizens.

“Companies that produce goods and services have to behave as citizens” he said, urging energy groups to use their specialist knowledge and expertise to advance rather than block progress.

As for the framework becoming a reality, Nordhaus said the idea was “percolating” through colleagues and students carrying the idea into the future. He urged governments to get involved with the idea and raise the price of carbon. As to whether the tax would hurt those on a low income who tend to spend more on energy, he referenced different ways to tax carbon.

For example, British Columbia has a system characterised by a tax and rebate that offsets the regressive nature of carbon taxes.

“Revenues can be off set; British Columbia has created a system that is progressive in the way it rebates,” he concluded.

To view all session recordings, the conference program, stories and white papers visit the Sustainability content hub here.

Bridgewater’s three dimensional approach

Investors should shift from only looking at risk and return to adopting a three-dimensional model that incorporates impact, said Karen Karniol-Tambour, director of investment research at Bridgewater Associates where she heads up more than 150 investment professionals.

Speaking at Sustainability Digital, she urged delegates to put capital to work to finance solutions that can make a difference to the world. Noting that a few years ago such an idea seemed “aspirational,” she said today it is now “possible and achievable” for investors to think about risk, return and impact, accomplishing all three across all asset classes.

“It’s a huge change in perspective,” she said.

Investing for risk, return and impact involves systematically picking assets with specific goals in mind. She said the SDGs are broad but also hold specific targets and said investors should assess how each asset furthers the SDGs, choosing investments that have the most positive impact. She said the SDGs provided investors with a broad map of where to go and the ability to connect investment with goals.

“You will see those assets that have an impact are not that much different to other assets,” she said.

She noted that because investors can pick a wide range of assets, they don’t have to sacrifice return and can achieve a balanced portfolio. She said investors of “any size” could shift their mentality to achieve all three of these things.

Karniol-Tambour said integrating the SDGs could include making a commitment to net zero. You could make net zero the goal and set that goal, she said, reiterating that it would mean assessing every asset in the portfolio against that goal.

“There are a sufficient number of very scalable assets that would allow you to build a great portfolio with that goal in mind,” she said.

Karniol-Tambour said the availability and quality of data will get better, allowing investors to move in this area. Regarding Bridgwater’s research processes, she said the firm didn’t want to go off “reputation” and “policies” but did a deep dive into companies activities. This has involved sifting through multiple research organizations – a process that involved looking through 35 research organizations, and picking three.

She said that the current data available made it difficult to identify black swans in ESG. For example, research into the risk of a pandemic never flagged the reality of what COVID-19 has unleashed.

“There are a very wide range of outcomes,” she said. “The most important thing is to stress- test, think about extreme events and think about how much protection you need to buy.”

However, she noted the challenge of being “over concentrated” on an outcome that never materialises.

Inflation linked bonds

She noted that one-way investors can navigate government policy and incorporate sustainability is via investing in inflation-linked bonds. Large allocations to equities to escape the impact of low-yielding nominal bonds has left many investors “naked” to a large range of outcomes. Inflation-linked bonds issued by multilateral organisations that have sustainability enshrined in their mandates offer one solution.

“You know where the capital is going and it is inflation linked,” she said, flagging concerns of rising inflation in coming years. “This is well suited to balance stocks in your portfolio and is more useful than a traditional nominal bond.”

She explained to delegates that ESG factors will be critical in generating alpha in the years ahead and noted that some of the SDGs offered opportunities because they attracted much less capital.

She explained that it is impossible for investors to look at the world today without thinking about ESG and said that investors are operating in a difficult climate characterised by the downturn, the backdrop of zero interest rates and money printing as well as the impact of government policy.

She added that the huge expansion in the wake of the GFC was successful in terms of easing unemployment, but social conditions deteriorated.

“Today the pandemic has caused macro factors to deteriorate as well as social conditions,” she said.

She also flagged the divergence in different regions of the world to navigate climate change. For example, Singapore and Canada will fare better than regions in Asia and Latin America where climate change will impact long-term growth.

For all the conference sessions, stories and white papers visit the Sustainability content hub here.

The Ford Foundation outlines its ability to achieve impact and returns and announces plans to invest for impact in public markets in the next 18 months. Elsewhere, renown impact investor Pictet Asset Management explains how impact investment is becoming more mainstream – and should include active engagement.

A key pillar to impact investment at The Ford Foundation includes mandating to diverse fund managers. In what Roy Swan, director, mission investments, at the Foundation called “devastating” statistics, only 1 per cent of the estimated $71 trillion managed by the US investment industry is managed by firms run by women or people of colour. ‘

“Access to capital is access to capitalism,” he told delegates at Sustainability Digital, explaining how the Ford Foundation strives to put more capital into the hands of historically disadvantaged people.

“All those managers will deliver the kinds of financial returns that we believe are important,” he said.

Swan explained that the foundation, America’s largest impact investor, runs a mission-related program that seeks to invest in social problems for a positive impact and appropriate risk-adjusted return. Alongside funding diverse asset managers, investments include social housing as well as investment in financial inclusion and biotech sectors in developing countries. The foundation has exclusively focused on private markets but will expand into public markets in the next 18 months, he said.

Despite measurement being often cited as an obstacle for institutional investors to invest in impact, Swan also explained that the mission investment program avoids sophisticated measurement frameworks because the impact from its investment is clear to see. For example, the shortage of affordable housing in the US means measuring the number of units of housing the foundation can preserve or create is sufficient.

Similarly, the impact of investing in diverse funds managers given the stark lack of investment capital mandated to these managers makes the impact clear. Telling delegates that this “high level approach” would be refined over time, he said the problems the foundation targets loomed large enough to make it possible to “simplistically approach” measuring impact.

Fellow panellist, Laurent Ramsey, managing partner and chief executive of Pictet Asset Management told delegates that there was “no downside” to having an additional impact lens through which to examine factors that could have a material impact on the price of an asset. It helps to mitigate risk and unearth interesting opportunities, he said.

He said that many sustainable strategies had “fared well” through the pandemic. Moreover, public policy and regulation like the EU’s green deal is pushing more capital towards impact investment. Elsewhere, MIFID II regulation will require financial advisors to take account of sustainability risk in their selection of financial products presented to investors in a “structural change that is here to stay.”

Impact is being integrated across asset classes, said Ramsey. It is possible to measure positive impact in private equity and debt and real assets, however he noted that these kinds of investments are difficult to scale. Channelling capital into impact via the public markets is increasing too, he noted.

“It is a pity not to use public markets to drive positive change given the sheer size of public markets,” he said.

He also noted that impact investment in thematic investment and via active ownership – whereby investors not only use their voting rights but engage with companies – had to involve investors ensuring investee companies’ products and services held solutions.

In fixed income he noticed the “acceleration of issuance” in the sustainability space around green bonds linked to impact. For example, Italian energy giant ENEL has issued €1.5 billion bond linked to energy transition targets structured so that failing to meet the targets gives a higher return to investors. At under 1 per cent of outstanding debt, he said it is still “a small space,” but with tailwinds and governments creating incentives, impact in fixed income it also sure to grow.

He said one of the best ways to measure impact in public markets was via engagement.

“Over the years you can push them to divest from activities. When you engage in public markets you have a better sense of that measurability,” he said.

Ramsey told delegates that the fund manager has only recently seen a spike in investor demand for impact. Strategies include investing in a fund to help solve water scarcity, that celebrates its 20 year anniversary, as well as thematic investments that look at mega trends and structural changes in the economy.

Ramsey added that impact differed to mainstream ESG because it involved ensuring the products and services offered by investee companies held solutions. When Pictet created its water strategy the firm had the double benefit of investing in companies generating above average growth rates and good financial returns, alongside allocating capital to companies providing solutions. He also noted that it is now possible to draw on more scientific research to allow more precision in investing for impact, adding that engagement is a crucial piece of the puzzle.

“Even these companies providing solutions have areas of their business they can do better, engaging with management is rewarding in terms of transition and returns,” he said.

Elsewhere Ramsey noted that Pictet’s partnership model has aided and abetted its impact strategy because it lends to the long-term.

“We are a custodian of the company for the future,” he said, adding that by not being listed Pictet can serve all stakeholders and is not trying to satisfy only shareholders. “A partnership structure and sustainability make a good framework,” he said.

He also stressed the close connection between impact and returns. Pictet’s water fund has outperformed world equity markets 17 years of the last 20 years.

“It doesn’t happen every time,” he said. “But there is evidence that the impact lens and identifying themes that benefit from the transition can be rewarding.”

At the Ford Foundation, which has to return 8 per cent a year, returns are clearly superior in some impact areas like affordable housing where Swan noted the gap between actual and perceived risk. “The risk is low versus the returns,” he said.

For the full recording of this session, all the conference sessions, relevant white papers and stories visit the Sustainability content hub here.