Not waving but drowning: navigating the oceans of 'green finance' speak

For Mark Carney, governor of the Bank of England, the 'global problem' of climate change is crystal clear, but do we yet fully understand the words and concepts?
by George Littlejohn, senior adviser to the CISI


The greening of Europe
Wherever Brexit leads, Europe has a key role to play in the development of taxonomies. Ursula von der Leyen, president-elect of the European Commission, laid out her political guidelines in summer 2019 in a 24-page manifesto that emphasises the ‘greening’ of policy – including the green commitment of the newly appointed European Central Bank President Christine Lagarde.

Euro-guru Graham Bishop comments: “The greening of finance will be the hallmark of the next European legislative period and the Commission’s 2018 proposals are now grinding their way through. These cover the framework for sustainable investment – including the key taxonomy of definitions, corporate disclosures, green bonds and green benchmarks.

“The difficulties in creating a taxonomy of conditions to be fulfilled to avoid ‘greenwashing’ triggers much discussion. It is becoming apparent how wide-ranging the TEG proposals will be as banks will soon find that it becomes a part of the supervisory review and evaluation process through which regulators assess and measure the risk for each institution, to show how their loans are helping to meet the targets. Importantly, Europe may get the first-mover advantage by developing these standards first – though in consultation with other global authorities.”
Albert Camus did not know the worlds of green, or responsible, or sustainable, or ESG, or impact investing. But he would have empathised. The facts of climate change speak for themselves, but the investment world is yet to arrive at a precise definition of what these many and overlapping words and concepts mean. Uncertainty abounds and unlike its cousin risk, the lifeblood of the financial world, it is not a welcome guest.

Climate change presents an unprecedented challenge to the financial system. Financing the transition to sustainability is key to success. To tackle that, investors need transparency on what ‘sustainable’ finance frameworks mean, and in particular on definitions.

Taxonomies – classification systems – are essential to defining what we mean. Brazil, China, and other countries, already have their own. The EU’s High-Level Expert Group on Sustainable Finance launched a study on the subject in 2017. In March 2018, its recommendations were incorporated into the EU’s ‘Action plan: financing sustainable growth’, which established a technical expert group (TEG) to develop an EU-wide taxonomy, a green bond standard (GBS), benchmarks for low-carbon investment strategies, and improved climate-related corporate disclosures. And in June 2019, the EU expert group published reports on a taxonomy of sustainable activities, the EU green bond standard, and climate benchmarks, and the European Commission published guidelines on corporate climate-related information reporting.

Investors, both institutional and retail, need clear ‘labels’ tied to the coming taxonomy to ensure their money is going where they think it is. This surging business has attracted huge and growing funds, and the related baggage of unwelcome activity, such as ‘greenwashing’ and worse. Asset managers, institutional investors, and pension fund trustees also need clarity when bringing non-financial measures into their decision-making. Retail advisers need to know how best to assess their clients’ wishes in this arena. And at the other end of the scale, the issues involved have strong, tidal pulls on prudential and disclosure requirements for institutions. (The latter is in the ambit of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures, TCFD, which is encouraging ‘voluntary, consistent climate-related financial risk disclosures’ for use by companies in providing information to investors, lenders, insurers, and other stakeholders.)

Taxonomy for sustainable activities

The taxonomy starts with climate change mitigation and adaptation. At present, this does not cover social objectives, apart from minimum social safeguards for all environmentally sustainable activities. But the June proposal does commit the Commission to publish a report on the appropriateness of extending the taxonomy to other sustainability objectives, notably social ones.

In its June report, the TEG experts propose some 67 activities that significantly contribute to climate change mitigation, together with relevant technical screening criteria. These cover seven sectors, including energy, transport, agriculture, manufacturing and buildings – and together present the most comprehensive classification system for sustainable activities to date. The TEG report also presents principles for climate change adaptation, which can be applied to a wide variety of sectors.

The EU green bond standard

The June expert proposals to the Commission involve the creation of a voluntary, non-legislative green bond standard to “enhance the effectiveness, transparency, comparability and credibility” of the green bond market and to encourage participants to issue and invest in green bonds. It has four key strands:

  • Alignment with the EU taxonomy for use of proceeds – in other words, assurance that the bond proceeds are being used appropriately.
  • The publication of a green bond framework, which will confirm the (voluntary) compliance of EU green bonds with the standard, and in particular how the issuer's strategy aligns with the environmental objectives. It will also encourage publication of details on all key aspects of proposed use-of-proceeds, processes, and reporting.
  • Following the bond issue, the report envisages mandatory reporting on use of proceeds (an allocation report) and on environmental impact (an impact report).
  • A further mandate will involve verification of the green bond framework and final allocation report by an independent third party.

Next moves on these are down to the new Commission, which started work in November.

The importance of disclosures

Measuring climate change effects, and translating these into hard reported figures is another challenge. Climate and broader sustainability issues are key elements in long-term value creation. Sound information is vital if investors are to develop and maintain properly-informed strategies. The FSB’s disclosures report (TCFD) is a major milestone to set a common standard around the definition of material climate information.

Veronica Poole, Deloitte NSE head of accounting and corporate reporting, believes that: “Climate change is an existential threat that demands urgent attention; there can be no more ‘business as usual’ if companies are to protect their value, manage risks and future-proof their organisations.

“Climate change is likely to drive some of the most profound changes to businesses in our lifetimes. Impacts on products and services, supply chains, loss of asset values and market dislocation are not only being caused by more frequent and severe climate-related events, but also by the accelerating pace of policy and regulatory change.”

The TCFD proposals on reporting are key to obtaning and maintaining a grip. Dr Nigel Sleigh-Johnson, head of financial reporting at ICAEW says: “The support of G20 governments and the distinctive approach adopted by the TCFD – focusing on communication of the financial impact of climate change on the organisation – mean that the recommendations could act as a catalyst for significant improvement in the quality and consistency of disclosures and governance.”

This article was originally published in the October 2019 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.

Once you have read the print edition, keep coming back to the digital edition of The Review, which is updated regularly with news, features and comment about the Institute and the financial services sector.
Published: 04 Dec 2019
  • Wealth Management
  • Bonds
  • taxonomy
  • sustainable investing
  • social and governance
  • greenwashing
  • green finance
  • green bonds
  • ESG
  • environmental
  • climate change

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