The European Union has a prime opportunity to lead the world in the development of green capital markets following discussions about unifying capital markets with sustainability reporting and ‘green’ directives, says Philippe Zaouati, CEO of asset manager Mirova.
The green transition offers a “unique opportunity” to build a European capital market that transcends national borders, Christine Lagarde has recently told the European Commission. It is a move that many hope will help power an economic transformation and support the flow of capital to areas lagging behind in the sustainable transition.
Leading the charge in green capital markets is an admirable ambition, particularly given the urgent need for action. As outlined by Lagarde, Europe needs investment of €330 billion every year by 2030 if it is to hit its self-imposed climate and energy targets and the Commission’s plan will help achieve this. However, while welcome, it is also a plan that inevitably faces numerous challenges before it can become reality.
There is no single silver bullet or answer as to how the EU can set about achieving its laudable aims, but there are key challenges we at Mirova have identified that, once addressed, could help set the union on the right path.
Firstly, Europe needs to understand the scale of the challenge it faces and what a transition to ‘net-zero’ really means. Pledges to hit net zero by 2050 have come thick and fast in recent years, with pressure from investors for greater action on carbon emissions and the climate growing by the day. The International Energy Agency (IEA) has already warned that this cannot be achieved simply by marginal adaptations to business models, the change needs to be radical and will likely involve a root-and-branch assessment of how businesses function.
It is an immense challenge, and we must fully grasp the size of the issue to be able to make informed decisions. We must understand that the shift requires an overall ‘Schumpeterian’ creative destruction that cannot be considered at the single issuer level. There will be winners, and there most certainly will be losers, as well as significant divestments.
As a first step, understanding how to adapt EU industry policies accordingly and then designing a path towards EU taxonomy will be key. How can we take concrete steps towards standardisation? How can financial products integrate this goal quickly and realistically?
This ties in to our second point, that we need to see the implementation of common standards to classify funds according to the level of sustainability ambition. Financial markets participants need to be able to understand which investment vehicles will support an effective and fast transition and which ones can only marginally modify the trajectory.
A reliance on voluntary labels is simply too marginal compared to the need to scale up the entire investment industry. The SFDR debate on the classification of funds has demonstrated the need for market standards and regulation and has been a game changer in terms of requiring all market participants to classify their funds according to their level of sustainability ambition, raising the interest of investors all over the world. But the work seems to have stopped halfway, and we need more detailed categories for products to align with, or there is a high risk of market fragmentation.
The link between these strengthened standards and categories should be clearly established with the MIFID delegated act, that, to date, makes no full connection between the expression of a sustainability preference and SFDR categories.
Equally, we should look beyond data disclosure and collection in order to go the extra mile on ESG analysis. Yes, data collection is important, but only if we understand what we are gathering, why we are gathering it, and what we are going to do with the information we receive.
We also must realise that the data we collect will not be perfect – and we must be flexible in our approach and look to ‘imperfect’ data to help build a fuller picture of the limitations and opportunities in an asset. Likewise, with no one data set able to provide all the answers, investors must also be able to integrate qualitative factors in the quest to add value when making investment decisions. The integration of sustainability disclosures, as supported by the EC and Lagarde herself, would in her words create a “one-stop shop” for all critical information about a company, including its green credentials, to help investors.
An EU green capital market union should serve as a reference point for others and bring a sense of coherence for continuing efforts to develop ESG and sustainable finance around the world. In tackling the three challenges mentioned above – taking the full measure of what net-zero means; setting standards and finalising the job on SFDR and the taxonomy; and broadening the data-alone approach to analysis.
It is important to remember that this requires pragmatism and an approach that connects green finance to citizens, entrepreneurs and everyday life.
We must keep European regulations simple, rational, and efficient in order to reach sustainability goals. Developing a simple and pragmatic approach will enable the EU to have a more open dialogue with US and Asian markets for instance, and enable the EU to effectively demonstrate its leadership and support other geographies to increase the financing of and focus on sustainability.