The PRI will announce the winners of its inaugural awards at the PRI in Person in Paris in September. The awards are one of two new initiatives aimed at showcasing leadership and increasing accountability as part of its Blueprint for responsible investment.

The other initiative, a Leader’s Group, will showcase signatories at the cutting edge of responsible investment. These examples of best practice will become a learning for others with the information around their implementation of responsible investment made public and available for other signatories to explore.

There will be five awards with finalists spanning both asset managers and asset owners.

The awards will highlight projects ofinnovation and impact, with a shortlist agreed by a panel of independent judges using a points-based methodology. There were 140 entries received from 23 markets around the world.

“We were thrilled by the high calibre of entries to our inaugural awards, which strongly reflect the diversity and innovation of PRI’s global signatory base. In acknowledging excellence through these projects, we aim to showcase leadership and new ideas to inspire responsible investors around the world.  The entries show that whether you are large or small, from developed or developing markets – responsible investment is possible,” Fiona Reynolds, CEO of PRI, said.

PRI signatories were invited to nominate projects across four categories: ESG incorporation, active ownership, ESG research and real-world impact, with an additional award to be presented for the best project submitted by a signatory headquartered in an emerging market.

The external judging panel is:

  • Eric Usher, UNEP FI
  • Lise Kingo, UNGC
  • Helga Birgden, Mercer
  • Stephen Miles, Willis Towers Watson
  • Brad Barber, University of California Davis
  • Nick Robins, LSE
  • Laura Starks, University of Texas Austin
  • Matt Orsagh, CFA
  • Jeanne Stampe, WWF Asia

Inaugural PRI Awards shortlist: 

Active Ownership Project of the Year

  • Glencore 2019 climate change position statement, Church Commissioners for England (UK)
  • Cadmos Peace Investment Fund, de Pury Pictet Turrettini & Cie (Switzerland)
  • Leading Collaborative Engagement in support of Climate Action 100+, Hermes EOS (UK)
  • Australian Infrastructure Sustainability Initiative, IFM Investors (Australia)
  • Platform Living Wage Financials, MN (Netherlands)

ESG Incorporation Initiative of the Year

  • Blueprint for Advanced ESG Integration, BNP Paribas Asset Management (France)
  • The Systematic Investing Multi-Factor Opportunities Strategy (SIMON) – Integrating ESG, First State Super (Australia)
  • Pricing ESG risk in credit markets, Hermes Investment Management (UK)
  • Climate VaR Integration, Neuberger Berman (USA)

ESG Research Report of the Year

  • Impact-Cubed White Paper: measuring the sustainability impact of 25 European ESG funds, Auriel Investors (UK)
  • Managing risk associated with modern slavery – a good practice note for the private sector, CDC Group (UK)
  • Coller FAIRR Protein Producer Index, FAIRR (UK)
  • Study of ESG information disclosure, Nissay Asset Management Corporation (Japan)
  • Applying scenario analysis to actively managed strategies, Rockefeller Asset Management (USA)

Category: Real World Impact Initiative of the Year

  • Impact investing for a better future, Aberdeen Standard Investments (UK)
  • Planet Emerging Green One, Amundi (France)
  • Australian Infrastructure Carbon Emissions Reduction and Energy Efficiency Initiative, IFM Investors (Australia)
  • Room2Run, Mariner Investment Group (USA)
  • Land Degradation Neutrality Fund, Mirova (France)

Emerging Markets Initiative of the Year

  • Responsible Investment, 2017 Annual Study, Performance of Latin American Investors, GovernArt (Chile)
  • Women in Finance, Granito Group (Brazil)
  • Kigali Bulk Water Supply Project, Investec Asset Management (South Africa)
  • Portfolio-wide Monitoring & Evaluation Platform, Old Mutual Alternative Investment (South Africa)
  • Green FoF: Innovative ESG Strategy with China Characteristics, Starquest Capital (China)

 

Profit margins for US companies are very strong, are they sustainable? In a word – no.

While US companies have some defensible profitability advantages, today’s elevated margin levels may be poised for a reversal of fortune. Six key factors have supported high US profit margins: increased globalisation, cost-reducing technological advances, broad declines in labor’s negotiating power, less restrictive anti-trust enforcement, lower corporate taxes, and cheaper credit costs.

Some of these key forces are starting to fade, while others still have some momentum behind them. On balance, the evidence suggests we are at or very near peak margins and should be prepared for margin compression over time.

According to analysis by investment research firm Empirical Research Partners, manufacturers in the S&P 500 index are responsible for half the index’s earnings and generate profit margins nine percentage points higher than the rest of the market. Their research revealed that manufacturers’ margin expansion was driven by three roughly equivalent factors: (1) wage savings from offshoring and robotics, (2) global tax arbitrage, and (3) falling interest rates.

The trade war directly threatens the part of the market that has generated most of the margin expansion—the tech sector and other global manufacturers.

Even without added tariffs and supply chain restructuring, future wage savings from offshoring may be limited. Chinese hourly manufacturing compensation costs have increased from 2 cents to 14 cents on-the-dollar relative to US costs since China joined the WTO in 2001, with all-in manufacturing costs coming close to parity with the United States.  Asian competitors (e.g., Vietnam, Bangladesh) offer lower production costs, but there are limits on their ability to handle the same types of manufacturing done in China without meaningful investment and time to improve.

Robotics appears to have plenty of room for continued penetration into manufacturing. The global operational stock of industrial robots has grown at a 10 per cent annual growth rate since 2009. US robotics use lags Asian countries, leaving more room for further robot adoption to cut costs.

However, even as automation reduces costs, improving margins of individual companies, such productivity enhancements could eventually reduce overall employee compensation enough to limit US consumption and ultimately the aggregate profit margins of its companies.

Globalisation and reduced employee bargaining power have contained wage growth. A sharp decline in organised labor and increased concentration in US industries have limited workers’ bargaining power, while concentration has also supported companies’ pricing power. According to the US Department of Labor, the percentage of US employees in a labor union has halved since the 1980s to just 10.5 per cent in 2018.

At the same time, increased mergers and acquisitions activity, amid decreased antitrust enforcement, has boosted industry concentration in the United States. Researchers Gustavo Grullon, Yelena Larkin, and Roni Michaely found that a commonly used measure of index concentration, the Herfindahl-Hirschman index, has increased more than 70 per cent since 1997, reflecting significantly higher market concentration among US publicly traded firms in the Center for Research in Security Prices database.

Finally, while it is possible for tax rates and interest expenses to decline further, this is not a reasonable base-case assumption, given the considerable decline in tax rates, the increase in government debt, and the very low level of interest rates. The effective tax rate of US publicly listed companies has fallen from about 45 per cent in the 1970s to about 20 per cent today. These forces may not reverse course in the near term, but they are unlikely to provide a means for further margin expansion.

Profit margins have remained elevated for an unusually long period as numerous forces converge to expand margins to new peaks.

However, the tide appears to be turning on some of these secular trends.

Even as companies see diminishing marginal gains from offshoring, falling rates, and lower taxes, negative sentiment toward globalisation and large companies in general has been mounting in the current populist environment. Profit margins are likely to compress over time, as globalisation trends become less favorable and as large companies come under pressure from politicians seeking improved income equality and increased market competition.

A decline in margins will take away one of the pillars that has supported an unusually high valuation premium for US equities relative to global ex US equities, one of several catalysts that could trigger a convergence back toward average historical levels.

Of course, timing of any such reckoning is unpredictable and could wait until the next recession, particularly as US equities tend to be defensive in times of stress.

Given the stage of the economic cycle, we continue to recommend modest underweights to US equities relative to global ex US developed and emerging markets equities. We would look to increase underweights in a recession-related bear market.

Celia Dallas is chief investment strategist at Cambridge Associates.

 

 

For more than 50 years, intensively reared animals have been the main source of protein for consumers worldwide, and a major ingredient for multi-billion-dollar brands like Burger King, McDonald’s and KFC.

However, the success of today’s dominant industrialised system of livestock and fish production has come at a cost. The industry is a key driver of antibiotic resistance and is the world’s largest user of freshwater resources. It is also the primary cause of deforestation, accounting for 80 per cent of all agricultural land and for 14.5 per cent of global greenhouse gas emissions.

Meanwhile, the overconsumption of animal proteins, particularly red and processed meat has been linked to a number of growing health concerns including cancer and diabetes.

Rising consumer awareness of these health and environmental concerns has coincided with a boom in food innovation and technology. Plant-based and cell cultured ‘meat’ are now able to replicate the taste, texture and flavour of traditional animal meat products without the associated environmental impacts.

With a growing abundance of tasty new products, two-thirds of consumers are already choosing to eat less meat and more plant-based food. Barclays, JP Morgan, AT Kearney and UBS all predict that the alternative protein meat market will capture a significant portion of the traditional meat market, with projections ranging from 10 – 60 per cent over the next 15-20 years.

For companies and investors alike, this presents significant opportunity, and some are already reaping the benefits. Burger King in the US will be launching the Impossible Whopper nationwide after locations in the trial market outperformed the company’s national foot traffic by 18.5 per cent. In the UK, Greggs’ share price has enjoyed a record high, since the launch of its vegan sausage roll, while Beyond Meat’s IPO this year was the most successful IPO for a major US company this century.

By contrast, companies that fail to adapt and innovate threaten their ability to compete, drive growth and achieve long-term sustainability ambitions.

Since 2016, FAIRR, a global institutional network of more than 250 investors has been engaging with 25 of the biggest publicly listed food manufacturers and retailers to encourage these food giants to adopt a comprehensive protein diversification strategy that will help de-risk soft commodity supply chains and drive growth.

We found that the majority of companies are expanding their exposure to plant-based foods.  All the retailers in our engagement have expanded their plant-based product portfolio through increased own-brand or external product offerings.  Some retailers have gone further, with 50 per cent supporting demand through dedicated internal resourcing. Sainsbury’s, for example, now has a meat-free product development manager and Tesco hired a director of plant-based innovation in 2017.

Manufacturers, for their part, are expanding their exposure to low-carbon proteins primarily through acquisitions and direct investments in plant-based food companies. Mondelez and Kraft Heinz have announced venture arms that include plant-based and alternative protein start-ups as part of their remit, while Conagra, Nestlé, Kraft Heinz and Unilever have acquired dedicated plant-based/alternative protein brands.

But, on the whole, ‘Big Food’ has only just begun its journey towards a low-carbon portfolio. No company in our engagement was able to demonstrate a comprehensive approach that includes board-level support to transition product portfolios to include low-carbon and less resource-intensive ingredients and products.

Investors therefore have an important role to play in encouraging their assets to understand the scale of the shift that is currently underway and to adopt a strategy to leverage innovation and new technologies to drive long-term value creation.

Jo Raven is the engagement manager at FAIRR.

Harshal Chaudhari recently sidestepped from his role as company-wide CIO at IBM where he has overseen strategy for the $150 billion defined benefit and defined contribution retirement pools since 2016, to a new role as the tech giant’s chief analytics officer. He spoke to Top1000funds.com on the strategy he ran at the pension fund, his wider thoughts on the global economy and the impact of technology on the investment world. The assets of IBM’s US and non-US DB pension plan’s are $48 billion and $37 billion respectively.

Sarah Rundell: Could you detail how investment strategy at the IBM pension fund has changed under your leadership and your motivation for those decisions? Where do you think your impact on the portfolio has been most significant during your tenure?

Harshal Chaudhari: The portfolio underwent substantial changes during my tenure. First and foremost we took significant de-risk actions which really followed logically from the strong returns we have achieved over the last three years. As the funded status increased by 7 percentage points we were able to reduce the surplus volatility by about half. We improved our liability hedge – both quantitatively by increasing the hedge ratio and qualitatively by designing a better curve match. We have gone through some sizable moves in interest rates and credit spreads since then and the hedge has performed extremely well. So, I am very happy with that outcome.

We also took the opportunity to simplify our asset allocation strategy. Simplification and reduction in the granularity of our asset class buckets now allows for a lot more flexibility for the investment team to add strategies and respond to market opportunities quickly while continuing to have appropriate governance control over aspects of risks that really matter.

We have also heavily restructured the growth portfolio. While it is smaller in relative terms it is still large in absolute terms and needs to work efficiently to deliver a large contribution to our total return objective. I inherited a strong developed markets active equities book and so it was an easy decision to reduce the passive allocation of 40 per cent to almost a fully active portfolio.

We also moved away from a mechanical rebalancing to index weights. One of our strengths is our in-house trading capabilities and so we have been able to manage beta overlays with ease allowing us to harvest alpha potential from our strongest managers without taking unintentional size or country bets. Emerging markets on the other hand was a different story. We had to start from scratch and revamp the entire portfolio. We took advantage of the fresh start to structure a great alignment of interest. Every new mandate now has performance-based fees supported by hurdles and clawback mechanisms. This did prove more difficult than I anticipated but in the end I am happy that we achieved fair structures for both parties in all cases.

Some of the most impactful things we have done are in the alternatives space. We meaningfully increased the allocation and have engineered a turnover of more than half of our hedge fund portfolio to focus on truly diversifying strategies. We have added about half a dozen new strategies and nearly doubled the number of managers in this portfolio while cutting correlation to equities by two thirds. On the private side, the de-risk has resulted in a reduced allocation for the US fund but we have taken the opportunity to leverage some of our best relationships and established programs with our non-US plan that still have a need to build up their funded status and therefore require higher returns. This has also allowed us to increase concentration and reduce the number of managers.

Returns are expected much lower in the coming years. What are your thoughts on the key issues facing financial markets today and the resulting challenges for institutional investors? What strategies should they put in place to prepare for low returns and a market drawdown, and where is the opportunity?

It feels like we have all been crying wolf about lower returns for many years now. I do hope the complacency does not set in as the downturn will eventually come – we just don’t know when. Markets and the global economy have proven very resilient despite numerous risks we can all enumerate, and it is hard to pinpoint what could be the eventual catalyst. I think it is prudent to be prepared. Knowing the risks inherent in the portfolio and focusing on true diversification is critical. As our fixed income allocation and exposure to corporate credit has grown as a result of our derisking actions we have been focused on reducing concentration risks and taking steps towards diversifying our sources of spread income. On the other hand, volatility is still reasonably priced and so adding high convexity strategies could be an opportunity for investors to continue to maintain equity allocations with some downside protection.

What are your thoughts on the impact of more rate cuts by the Fed for long-term investors, particularly fixed income investors/LDI?

A lower rate regime has been extended into the foreseeable future.  Combine the low rates with compressed credit spreads and it does present a challenge to fixed income investors in terms of the absolute return potential. However, I would argue that you still want a fixed income allocation in a general portfolio as the diversification purpose of the asset class is still intact regardless of your view on expected returns. And then, specifically for pension funds, a fixed income portfolio duration matched to the liability is the risk-free asset for a pension fund. So, if a fund has a hedging objective, I would advocate maintaining the course. In a holistic risk budgeting approach, mitigating unrewarded interest rate risk frees up budget to reallocate risk in areas with better risk reward trade-offs with arguably a higher probability of success than attempting to time interest rate moves.

What did you find most exciting and stimulating during your tenure as a CIO?

The learning, the relationships and an objective report card at the end of every period.  I have always been interested in investing and been seeking out investing books, research papers and blogs even before I assumed the role of the CIO. However, the focus was very limited. Being in the institutional investor seat opened the flood gates and exposed me to strategies I wasn’t even aware of before and led to a vast variety of learning in a short period of time. The more I dug into a topic and learned about something the more I realized how little I know and how much more there is to learn. This opportunity for endless learning is extremely intellectually stimulating.

Next is the people. Given our scale at IBM, we get access to the best minds in the industry. Ability to discuss, debate and bounce off ideas with the forefront experts, researchers, authors in the field has been a fantastic experience not only in terms of improving portfolio outcomes but also in forging strong partnerships between IBM and the respective firms. And then the opportunity that I did not appreciate enough prior to being in this role is the relationships I have developed with the broader institutional investment community and my fellow investors. I have found this community super friendly and delightful to engage with. Rarely did I find somebody not willing to share experiences and engage in learning together. These interactions have led to some very good friendships that I hope to continue to cherish for years to come.

Lastly, as a pension investor I enjoyed the balance between a) using the long-term focus to make decisions with a multi-year horizon and b) at the same time having the ability to periodically get objective feedback on how the decisions are panning out and if you need to course correct. It is a double-edged sword but using it to your advantage requires instilling a certain discipline to believe in your process when things are not going your way and at the same time constantly questioning where you may be wrong. This introspection is a stimulating exercise to sharpen the thinking and improving the process.

Could you talk a little about your new role? What will you be doing?
As the chief analytics officer, I lead a team of data scientists and strategy consultants focused on driving the adoption of advanced capabilities like big data and artificial intelligence to accelerate IBM’s reinvention as a cognitive enterprise. We have a broad mandate to pursue IBM’s most complex strategic issues to improve the business outcomes and achieve financial goals. We are looking at every functional area across the company, creating new AI-based solutions by leveraging diverse data sets – both internal and external -bringing our significant capabilities to bear across initiatives like sales productivity, pricing, marketing insights, skill development, fraud detection, to name a few. The solutions range anywhere from Robotic Process Automation (RPA) making existing processes faster and efficient, to deep learning techniques delivering cognitive business advisor assistance to senior executive decision makers.


Drawing on your expertise of both technology and investment, could you give a sense of how technology is going to change investment in the years ahead and the opportunities and challenges therein?
Just like any other industry, technology will profoundly change the way investment management will function in the future. AI will transform all aspects of investments from core alpha generation activities to risk management to back office operations. Ability to ingest high variety, velocity, veracity data, finding patterns indecipherable by humans and removing bias is immensely valuable. Bringing it all together to create a well-reasoned and relevant knowledge representation will become an integral part of the investment process and skills requirements.
At the same time, companies need to reimagine their teams and find the right mix of skills. While technology will certainly replace some tasks, more importantly it presents an opportunity to reimagine the way everyone works.

You can already sense the change that is coming. If you scan the careers website of investment firms today, do not be surprised to find the highest frequency keywords to be data science, Python, R, etc. Finding and retaining high-level AI skills around machine and deep learning, and at the same time investing and reskilling of the existing employee base is critical to forming high functioning T-shaped teams. Teams that can embrace technology, look beyond the inevitable short-term implementation hurdles to focus on long-term value and leverage the fundamental analysis skills, along with deep domain knowledge to ask the right questions of the data, will be best suited to thrive in the changing landscape.

QSuper CIO, Brad Holzberger, has long stood out from his peers by loading up on long-term government bonds and even the recent sudden collapse of yields, as investors started pricing in slower growth, hasn’t deterred him from sticking with this asset class.

“It doesn’t, it hasn’t and the reason it hasn’t is that the influence of falling bond yields affects all other assets,” he said. “Despite the recent fall in yields, the more strategic issue is that they have been falling for 20 years.”

Holzberger who has served as CIO since 2009, and will retire in September, admits to having “fewer positive expectations” of returns than previously but claims his balanced portfolio is essentially unchanged. “We made only very minor changes to the allocation and the mix of bonds held and those changes do not mask the strategic consistency,” he says. “We are often asked about our allocation choice but our answer can only be understood properly when we say we are equally concerned about the future for equity returns, unlisted assets and bonds.”

Given the weakening global growth outlook, the investment chief is more committed to diversification than ever and holding on to bonds is part of that strategy.

In practice, the fund’s portfolio reflects exactly that. The superannuation fund has allocated a solid 25 per cent of its $82 billion to fixed interest investment in complete contrast to the average balanced fund which holds a lower weight and is generally concentrated in credit exposure, rather than government bonds.

Outlier

Holzberger concedes QSuper has  been something of an outlier in the Australian superannuation industry since 2011 when apprehension over the spectre of QE drove it to adopt a highly-diversified strategy. Before that, like most other super funds at that time, he measured investment performance by how QSuper funds performed against its peers. That changed the moment QSuper’s balanced fund booked a negative return for the year, even though the fund beat its rivals.

Holzberger swung into action by slashing equities by half, to 28 per cent of the portfolio, and bolstering the fund’s exposure to high-duration bonds. His focus turned to achieving CPI plus returns, rather than being consumed by peer relative returns.

“We concluded that doing so required a different investment approach, one that could provide strong returns coupled with lower risk, as defined by annual volatility of returns. The previous, conventional way was much more equity reliant for performance, whereas way we’ve invested since 2011 is truly diversified by risk,” he notes.

“Our fund has looked noticeably different to the other balanced option funds in asset allocation terms for a good while now,” he adds.

QSuper has done very well through owning long-term government bonds. In 2018, the fixed interest portfolio delivered a return of more than 10 per cent, of which about 7 per cent was achieved through the jump in bond prices and the consequent capital gain as rates dropped.

The big question is what happens now that yield curves are flat?

“Lower yields and flatter yield curves suggest lower fixed income returns going forward, but that’s probably the case for most asset classes, he goes on to say, while conceding that yields may continue to stay low for years.

“We scour fixed income markets to ensure exposure that is most likely to achieve our return and diversification objectives. For instance, we don’t currently have exposure to Japanese bonds and favour Australian and US bonds, where yields are higher.”

Rising uncertainty

QSuper’s “risk balanced” investment approach was adopted because of heightened uncertainty. And uncertainty remains high.

“In fact, the singular word I would use about our future view is uncertainty. We have never been more uncertain than we are now.”  And as an investor looking out at the sea of assets that you are able to buy; they are difficult to understand. Moreover, the only reaction that we can sensibly think of is to remain very diversified and ensure that no particular action in any particular market or any particular assets class will strike success or failure for us because we can’t pick it.”

More recently, he says, the super fund has started increasing weights to non-core markets. “This encompass a range of developing markets, but also other developed markets that tend to be underrepresented (or non-core) in standard market-cap benchmarks. We expect to continue to increase allocations to these countries but do not see such exposures as a golden bullet to a low return environment.”

QSuper holds no corporate debt – since Holzberger regards corporate paper as non-diversifying asset and if he is going to hold interest rate exposure, he prefers sovereign bonds. Given that, he claims not to have any insight into any potential financial system crash caused by the massive growth of triple-B rated bonds.

But he is worried about the wider credit backdrop.

“We have unprecedented financial conditions, rates are at their lower bounds in many countries, we have a very unstable geopolitical situation,” he said. Add into the mix, he said the fact there are many democratic counties whose governments have forfeited their mandate and are unable to take strong actions. “Political views are polarising and becoming extreme and people are being given choices between these extremes which in turn means you get more extreme financial and political reactions to these circumstances.”

Plus, he has never seen the world this indebted. “We live in a world where households, governments and corporates have unprecedented debt levels and that must affect the quality of that debt and even though rates are very low for those entities, the very volume of debt concerns us. And we are very uncertain as to how it will play out.”

Since QSuper’s portfolio is already diversified he is not being forced to buy highly-priced private equity, infrastructure and property assets other than to maintain existing allocation when inflows are high. In fact, according to Holzberger, QSuper is approaching its illiquidity limit.

Aside from the 30 per cent of funds allocated to equities, 27.5 per cent is invested in unlisted assets, including stakes in Heathrow and Edinburgh airports and the Port of Brisbane.

Like his counterparts, Holzberger expects the private markets to provide an edge and funds can amplify that edge by taking big positions which are more likely to “move the needle”. He is a big believer in exploiting idiosyncratic risks in private markets where disclosure can be poor. “By bringing very strong due diligence, strong negotiating skills, and strong management skills, you can influence the assets which you can’t do in other spaces.”

Clearly, unlisted assets have done well because of falling interest rates. “People now say they don’t look so expensive because rates are so low but the relativities haven’t changed much.  Unlisted assets have done as well as bonds over the last ten years. We think the relativities look about the same.”

Like other investors, he is trying to get used to what the future holds when facing a decade of ultra-low rates and mediocre growth. Ask Holzberger if he would change his allocation now and he will say only if valuations were to change drastically in one asset class and he sees that as unlikely.

 

On June 18, 2019 the EU expert group for sustainable finance (TEG) published a proposal for a European definition of environmentally sustainable activities. The taxonomy is best compared to a green encyclopedia for financial market participants. An encyclopedia that provides guidance to investors that are looking to finance the transition to an  economy in line with the goals of the Paris Climate Agreement.

The TEG’s proposal is a major step towards a European definition of sustainable economic activities. It has the potential to be a real game changer in the long term through more transparency, lower transaction costs and better dialogue between investors and investees.

Standardisation as an accelerator

The Dutch financial sector has long been active in responsible investment and standardisation of the market for sustainable investments. As a large €250 billion ($280 billion)  pension asset owner and asset manager PGGM and PFZW have been using a taxonomy for impact investments for almost 10 years. The taxonomy for impact investments was developed by a team within PGGM and was initially aimed at four impact themes: climate change, water scarcity, healthcare and food security. Three years ago this initial taxonomy was extended to a taxonomy for investments in the UN Sustainable Development Goals, in cooperation with APG. Based on our experience and as the only representative of the pension sector, we were able to play an active role in the TEG and the development of the EU taxonomy.

Being a global investor, we believe that further standardisation and comparability of sustainable investment will enable the upscaling of investments that yield financial returns as well as positive societal impact. Like the Taskforce for Climate-related Financial Disclosures (TCFD) has done for disclosures on climate-related risk, a European taxonomy could set the standard for ‘green’ investments.

Transparency

We are facing major environmental and social challenges that require us to rethink the status quo of our economy. To mitigate climate change and adapt our economies to in a transition towards a low carbon – and eventually carbon neutral – economy is vital. The financing gap that the EU’s public sector is facing for this transition is currently estimated between $200-$300 billion of private capital annually. The aim of the  EU action plan for sustainable finance published in May 2018 is to get capital flowing to the economic activities that can contribute to goals of the Paris Climate Agreement and the EU’s goals of a carbon neutral economy in 2050.

At its heart the action plan aims to create a universal understanding and classification of these activities –  the taxonomy. The European Commission’s reasoning is that a definition of “green activities” – shared by companies, governments, financial institutions and researchers could increase confidence and decrease ‘green washing’. Consequently resulting in more private financing for the transition to a carbon-neutral economy by 2050.

The proposed legislation for a EU taxonomy is therefore focused on transparency requirements: financial institutions that offer green financial products must provide insight into the degree to which their offerings are in line with the taxonomy. This provides asset owners with better insight into how green a product actually is. It will also result in better offerings and better substantiated choices on the part of customers. The taxonomy also provides the basis for future labelling schemes for example to classify investment funds and bonds on their alignment with the EU environmental goals.

Less reputational risk

Even though the legislative obligations focus on transparency, the benefits of a common standard for financial market participants is much broader. The taxonomy reduces transaction costs and reputational risk for asset owners and investors, now working with their own taxonomies. In the current market investors have to make their own judgement call on what they deem “green”. Making such a call requires substantial research capacity. For some activities it might also include taking some reputational risk through including or excluding certain activities. This last part is particularly applicable for activities that are supporting the transition but are “not yet green”, such as the use of gas, the production of certain chemicals and the renovation of buildings.

The taxonomy includes specific guidance on transitional activities and high-emitting sectors; reducing emissions in these sectors could make a substantial contribution towards achieving the Paris climate objectives and the EU targets for 2050. By also giving these sectors direction, the TEG intends to move sustainable investments from a green niche to a broad investment universe. Because the classification is created through cooperation between policy makers, scientists, companies, civil society and investors, it can be seen as a broadly shared definition that investors can rely on.

Better Dialogue

All activities in the taxonomy are based on existing standards and scientific scenarios, such as those of the IPCC. The criteria for all activities are in line with existing EU legislation, policy and objectives. There are threshold values for almost every activity. This could include, for instance, a maximum gCO2/kWh for energy production, or references to recognized norms or certification schemes. Every activity also includes criteria for limiting negative impact on the other EU environmental objectives concerning climate change adaptation, waste, water, circularity and biodiversity.

The detailed information provides a starting point for the dialogue between investors and their investees on environmental performance. The criteria and metrics give guidance on what should be expected from a certain sector. By suggesting pathways for high emitting economic activities, the taxonomy enables a constructive dialogue on long-term sustainability goals. A dialogue that is essential for the transition to a cleaner economy.

What’s next?

The report of the TEG is only the first step in the classification of environmentally sustainable activities. The mandate of the TEG in its current form runs until December 2019. After that the TEG will be followed – most likely – by a permanent platform that will finish the taxonomy and monitor the uptake of the tool. In the remainder of the mandate, the TEG will focus on analysing data availability and increasing the accessibility and user friendliness of the tool  to enable an easy uptake by investors, lenders and issuers alike.

Brenda Kramer is a responsible investment adviser at PGGM. She is also one of 35 members of the European Commission’s sustainable finance technical expert group, TEG.