The growth crisis of sustainable finance

The growth crisis of sustainable finance



Sustainable finance is not green enough! No, she’s too woke ! Worse, a damn mess! launch the criticisms. Rather, she is going through a growth spurt.

Posted at 9:00 a.m.

Global mutual fund and ETF (exchange-traded fund) assets in sustainable finance tripled during the pandemic, reaching US$3 trillion by the end of 2021.⁠1 They have since fallen with the market correction, but the flows remain positive, despite the denunciations.

The most acerbic came from the mouths of the governors of Florida and Texas, heralds of the hard right and valiant defenders of oil and guns.

The shots are also coming from the left, for whom sustainable finance is either dark green or not. The European Union classifies bottoms as brown, pale green and dark green. Most seek to qualify for the prized category, those who achieve one of six goals without harming others.2

At the centre, ESG investments (environmental, social and governance criteria) are criticized for being a mess of poorly defined, poorly measured criteria and not always factors of stock market performance.

It must be said that the apostles of sustainable finance — I plead guilty here — have set the bar very high.

Informed by reliable intelligence on corporate behavior on environmental, social and governance issues, responsible capital will reward worthy companies and punish wrongdoers, especially those that fail to reduce their greenhouse gas (GHG) emissions.

Not to mention the promise of less risky and more profitable portfolios over the long term, which most studies confirm.

Finance plain and simple is already complicated, catering to a wide range of needs in terms of time horizon, risk appetite and beliefs about how best to beat the indices. Sustainable finance does not simplify things by piling up its requirements.

Difficult, but we are moving in the right direction

Investors need quality information for informed choices. It’s still a mess, but progress is expected with the standards of the International Sustainability Standards Board (ISSB) and their imposition by regulators, hoped for the most uniform.

Although these standards intended for investors will be limited to useful information for gauging the value of the company, excluding that which makes it possible to measure its impact on the environment and society.

European regulations insist on both types of information. Elsewhere, corporate impact disclosure will remain voluntary for a time, guided by the Global Reporting Initiative, whose standards will complement those of the ISSB.

ESG information will always remain raw material that investors will have to interpret and integrate into their decision-making grid.

This still young science continues to evolve, at unequal speeds from one manager to another.

And not everyone will decide the same difficult questions: should all oil companies be excluded? If so, what about the other major GHG emitters, steelmakers and air carriers? And banks, which pollute little, but which finance the oil companies? To stop where?

Is it better to invest in exemplary companies, even if they are expensive? Or rather in those who have a tainted balance sheet, but who are determined to clean it up and whose shares could therefore appreciate?

In other words, do you want to decarbonize your portfolio or the economy? Not easy to do well both, knowing that it will take huge capital for the conversion of traditional industry.

Investing only in renewable energies is a risky bet. Diversifying a portfolio, the ABCs of prudent management, involves questionable trade-offs, however.

The managers of the S&P 500 ESG index have been blamed for excluding Tesla, with its poor governance and union-busting practices, to keep ExxonMobil, which compares favorably with other oil companies.

Some investors will give up the ESG mix in favor of products targeting the environment or the diversity and integration of women and minorities. But there will always be customers who want to consider a variety of risks and opportunities.

In short, there is no single recipe, because not everyone wants the same dish. Unfortunately, individual investors are often tempted by the attractive formula offered on the menu. In the kitchen, fund makers know this and some play ambiguity to the point of greenwashing. Fortunately, regulators are asking for more transparency and punishing unsubstantiated claims.

Sustainable finance is advancing rapidly, but critics warn it has not matured. The savvy investor will review the ingredient list of the products they buy and ask to see the manager’s recipe. For yields and for our children.

1. Data from Morningstar. Including institutional investors, the Global Sustainable Investment Alliance estimated 12 times greater, at 35.301 billion, ESG assets at the end of 2020.

2. The six goals are climate change mitigation; adaptation to these changes; sustainable use and protection of aquatic resources; the transition to a circular economy; prevention and reduction of pollution; protection and restoration of biodiversity and ecosystems.

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