Climate positive investing is not greenwashing – a research perspective 

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UK institutional investors’ opinions on sustainability are changing. As the industry moves from ESG risk management to stewardship and now increasingly towards climate positive investing, there is ever more understanding that climate change generates profitable investment opportunities. As the product offering broadens, so does the risk of greenwashing – but thankfully, there are a number of regulatory initiatives and investment innovations that help address this. 

Attitudes towards sustainability are evolving rapidly 

mallowstreet’s first research project on ESG risk management and integration took place in 2019. The data we have collected since then clearly shows the progression in how UK pension funds view sustainability. Starting off as a risk consideration, ESG factors turned into action points for schemes to engage with their managers and collectively influence issuers to improve for the better. Net zero goals followed, but with them came increased scrutiny over transition plans. 
UK institutional investors are now facing a new frontier – one of decarbonising their portfolios and channelling capital towards climate positive investments. There is an improved understanding that climate change presents risks as well as opportunities – and out-of-date business models will see rapid declines in values and eventually turn into stranded assets. 
Majiri Ogbogbo, one of our interns last year, revisited data from Ryan Daley’s research on large UK pension schemes in 2021. He found a growing proportion of schemes which believe that ESG implementation can increase returns. In fact, only 4% thought meeting ESG requirements will have the opposite effect on their performance. 
The upcoming Trustee Report 2022 has identified key knowledge gaps that need addressing in the UK pensions industry. It will also shed light on the evolving understanding that there is no sacrificing of returns or a clash with fiduciary duty when schemes invest with the climate in mind. 

A net zero commitment makes schemes embrace sustainable investments 

Majiri and Ryan also revisited the DB Climate Risk Report and found that over half of schemes with assets over £5bn and about a quarter of schemes with assets between £1bn and £5bn had made a net zero commitment as of mid-2021 – and these proportions have almost certainly increased since. 
More importantly, the research showed that schemes that commit to net zero are more likely to allocate to green solutions and other assets which support sustainability. For example, 48% of schemes with a net zero commitment already invest in clean technology and sustainable infrastructure and 39% are exposed to green bonds. In contrast, schemes that have not set a net zero goal are half as likely to invest in these themes. 

Product labels can be confusing – and untrustworthy 

A recent blog entry from S&P Dow Jones Indices shows that neither carbon efficient nor fossil-fuel free funds, nor heavy ESG tilts with big exposure to companies with net zero targets are Paris-aligned. For example, the chart below shows that the S&P Carbon Efficient index has no exposure to companies with net zero targets, and actually aligns to a scenario equivalent to 2°C warming. 
Another interesting example is the S&P 500 ESG Tilted index, which has a heavy tilt of 30% exposure to companies with net zero targets. Unfortunately, the implied temperature increase of that index is above 2°C, which is the scenario that the world needs to avoid. 

Climate positive investing is not all greenwashing 

As attitudes towards sustainability evolve, UK institutional investors are increasingly prepared to go beyond risk management, engagement, and net zero targets – and invest in climate positive strategies. But how can they do so if product labels are not to be trusted? Thankfully, there are several regulatory and reporting initiatives that aim to combat greenwashing. 
SFDR Article 9 funds 
SFDR stands for the Sustainable Finance Disclosure Regulation, a European regulation introduced to prevent greenwashing and increase transparency around sustainability claims by fund managers. An Article 9 fund under SFDR must have a sustainable investment objective and measure the attainment of the impact it targets, for example by reporting carbon emissions reductions on an annual basis. 
In contrast, Article 8 funds merely have to promote environmental or social characteristics and demonstrate how they do this, which could be via engagement and voting. Article 6 covers ESG risk consideration and integration approaches instead. 
Under the European Securities and Markets Authority (ESMA)'s proposed additional regulations, for a fund to use "any ESG-related words" in its name, at least 80% of its holdings must be "used to meet the environmental or social characteristics or sustainable investment objectives". This is a testament to the growing efforts of regulators to minimise greenwashing. 
As a result, the last six months have seen several asset managers downgrade Article 9 funds to Article 8. There may be more disclosure issues that remain unaddressed, as well as many upgrades from Article 6 to Article 8 that may need further credentialization, but the direction of travel is towards improved transparency and accountability. 
Regulators are not stopping there – for example, the French financial market authority AMF has proposed to ban fossil fuels from Article 9 funds and severely restrict them in Article 8 funds, to only include those companies which have a "convincing transition plan." Regulatory action against greenwashing will likely accelerate as the market innovates further. 
SDR Sustainable Improvers 
SDR stands for Sustainability Disclosure Requirements and is the FCA’s answer to SFDR post Brexit. It proposes a package of measures aimed at combating greenwashing, including investment labels, disclosure requirements and restrictions on the use of sustainability-related terms in both product naming and marketing. The consultation on this package closed on the 25th of January and final rules are to be expected in the first half of 2023. 
Under SDR, ‘sustainable impact’ funds would be investing in solutions to environmental or social problems, to achieve positive, real-world impact. We think this is roughly equivalent to Article 9 under SFDR, and not to be confused with ‘sustainable improvers’, which would include investments to improve the environmental and/or social sustainability of assets over time, including in response to stewardship and engagement efforts. There is an additional category of ‘sustainable focus’, which would be invested in assets that are environmentally and/or socially sustainable. 
Thematic funds and Sustainable Development Goals 
Thematic funds typically invest in stocks in different sectors that fit a theme based on different screens and/or fundamental criteria. Examples of themes can include: regenerative economy, energy transition, climate transition, health and nutrition, but also so many more – almost too many to name. 
Some thematic funds are centred around one or several Sustainable Development Goals (SDGs). They are the United Nation’s ‘call to action to promote prosperity while protecting the planet’. There are 17 SDGs to choose from, and each comes with several ambitious but broad targets: 
  1. No Poverty: End poverty in all its forms everywhere. 
  2. Zero Hunger: End hunger, achieve food security and improved nutrition, and promote sustainable agriculture. 
  3. Good Health and Well-Being: Ensure healthy lives and promote well-being for all at all ages. 
  4. Quality Education: Ensure inclusive and equitable quality education and promote life-long learning opportunities for all. 
  5. Gender Equality: Achieve gender equality and empower all women and girls. 
  6. Clean Water and Sanitation: Ensure availability and sustainable management of water and sanitation for all. 
  7. Affordable and Clean Energy: Ensure access to affordable, reliable, sustainable, and modern energy for all. 
  8. Decent Work and Economic Growth: Promote sustained, inclusive, and sustainable economic growth, full and productive employment, and decent work for all. 
  9. Industry, Innovation and Infrastructure: Build resilient infrastructure, promote inclusive and sustainable industrialisation, and foster innovation. 
  10. Reduced Inequalities: Reduce inequality within and among countries. 
  11. Sustainable Cities and Communities: Make cities and human settlements inclusive, safe, resilient, and sustainable. 
  12. Responsible Consumption and Production: Ensure sustainable consumption and production patterns. 
  13. Climate Action: Take urgent action to combat climate change and its impacts. 
  14. Life Below Water: Conserve and sustainably use the oceans, seas and marine resources for sustainable development. 
  15. Life on Land: Protect, restore and promote sustainable use of terrestrial ecosystems, sustainably manage forests, combat desertification, and halt and reverse land degradation and biodiversity loss. 
  16. Peace, Justice and Strong Institutions: Promote peaceful and inclusive societies for sustainable development, provide access to justice for all and build effective, accountable and inclusive institutions at all levels. 
  17. Partnerships for the Goals: Strengthen the means of implementation and revitalise the global partnership for sustainable development. 

Check the label, as well as the strategy 

Article 9, sustainable improvers, thematic and SDG funds can overlap. In other words, a thematic fund is not automatically recognised as Article 9 or a sustainable improver fund. Even a fund targeting several SDGs at the same time may not necessarily qualify for these regulatory labels. 
It is equally important to understand what each strategy is invested in, regardless of its label and theme, as there are endless combinations of them. Here are some assets often included in climate-positive investment solutions: 

Natural capital has specifically come into focus as a result of the UK government’s Environmental Improvement Plan, which includes ambitious steps to: restore wildlife habitat, expand National Nature Reserves, increase green spaces in cities, increase household water efficiency, reduce air pollution, improve access to finance for farmers, landowners and foresters, reform farming subsidies to incentivise the adoption of nature-friendly practices, and reduce waste. 
Natural capital investments are not to be confused with integrating natural capital risk considerations, or nature-positive engagement, which focuses on influencing issuers to consider their impact on and make efforts to preserve natural capital, halt biodiversity loss and other environmental impacts beyond GHG emissions. 

So, which way for climate positive investing? 

The variety of options available to UK institutional investors keen to play a part in the climate transition is expanding rapidly, despite the greenwashing challenges this presents. To understand how pension funds and insurers in the UK are re-thinking their portfolios, mallowstreet is planning in-depth research projects on natural capital, social impact and climate positive investing as a whole. Contact us if you are interested in becoming a research partner.

Ryan Daley

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