You can’t measure what is not there

Let’s us pause for a moment and consider the validity of this argument. A succession of directives and regulations have started piling up in a very short period of time demanding of corporations and financial institutions to declare, register and monitor a series of indicators that in the past were mostly left unaccounted for or even only randomly collected. On the governance side of things, this meant that there were not necessarily policies or procedures in place to track relevant elements also because it was not a place where an auditor or a supervisory authority would ever have to put their lenses in, unless they were purposefully asked to do so.

Out with the old and in with the new

What’s most important is that when it comes to sustainable finance, the legislative train has not yet arrived at the final station, at least for some of the most strategic pieces of regulation.

Flavia Micilotta, ESG investment specialist, Wealins

What’s most important is that when it comes to sustainable finance, the legislative train has not yet arrived at the final station, at least for some of the most strategic pieces of regulation. This means that not everything is cast in stone and that industry players still have to brace themselves for more changes impacting directly their business and operations. Faced with these ever-changing scenarios since 2021 has meant that financial market participants and other corporates, have had to be quite dynamic and flexible in the way they responded to these changes. Concretely they have had to adapt and ensure their understanding and communication of ‘sustainability risks and considerations’ met some new requirements, or standards, that did not exist in the past. Having to translate existing documentation into a new format can be troublesome enough, but for some actors, it was more about ‘creation and disclosure’ in one shot. In fact, it seems that this may be an issue that was largely overlooked by regulators, or was it?

A chicken and egg situation

In fact, the motivation behind the Sustainable Finance Action plan was trying to pursue two goals: 1) channel more capital to ‘real’ sustainable investments in order to 2) foster more private finance to fight climate change. The two goals presupposed that ‘sustainable investments’ was an objective concept easy to convey in financial instruments and that the fight against climate change was going to follow a path with no major disruptions, except for the occasional world leader questioning the very existence of the issue. Unfortunately, as it often happens with assumptions, things proved way more complex. Regulators were confronted with the problem of defining what a sustainable investment is and isn’t, while at the same time having to reconcile that with other regulations that were just ‘in the making’– EU taxonomy, for instance, and which were going to become part of the mandatory literature for sustainable finance. Agreeing on a definition that can be understood by everyone is difficult, but things get very tricky when they have to fit Regulatory Technical Standards (RTS) that need to be derived from data that is not readily available because it was not previously measured.

Regulators were confronted with the problem of defining what a sustainable investment is and isn’t, while at the same time having to reconcile that with other regulations.

Flavia Micilotta, ESG investment specialist, Wealins

Less is MORE

What about cumbersome? We referred to several directives and regulations being directly and indirectly interconnected (SFDR, CSRD, EU TAXONOMY, IDD II, Solvency II and the list is growing) and all of them require specific types of reporting that explains the sustainability features of products to enable investors to make an informed choice. Unfortunately, at present at least, there does not seem to be a lot of interaction between the different disclosure requirements and the result is that investors find themselves simply overwhelmed with too much data that is not tailored to their needs and that is mostly difficult to decipher. Insurance Europe has recently highlighted an horrific truth, and that is that for a citizen when buying a green insurance-based investment product online, EU rules require you to be given 339 pieces of pre-contractual information¹.

The future is yet to come

It is still early to tell how efficient the plethora of Sustainable Finance legislation they will be as a tool to provide better and clearer information to investors and to guide towards the right types of investments. What is sure is that one of the main expectations should ultimately be to bring to the fore the review and analysis of those intangible values underpinned by ESG which are today quintessential to understanding the potential of a company and its long-term sustainability. In essence, empower investors (even retail ones) to make a responsible informed decision and have the possibility to opt for a sustainable investment that is able to deliver on its promise.

Connecting the dots and building credibility are the essential elements needed to be able to move forward together. At the same time, establishing definitions based on regulations that follow very precise rules can be strenuous, particularly if to begin with, the knowledge around sustainability and the implementation of its rules was not based on clearly defined pre-existing standards.

As it stands, it seems that increased disclosure requirements have successfully increased the burden on product manufacturers with no significant increase in consumer protection, for the moment, that is. But let’s be hopeful, Rome was not built in a day.

¹ Insurance Europe ‘Five steps to ensure the EU Retail Investment Strategy works for consumers’ 2023