The European Union, under its taxonomy, requires SRI funds to declare what part of their portfolio is green by 1 January 2023, but there is still much work to be done to address the pitfalls in the EU’s sustainable finance framework, Triodos Investment Management’s Hadewych Kuiper and Nikkie Pelzer (photo) said in an interview. “Some asset managers prefer to classify their sustainable funds under Article 6” because it requires less reporting, making it cheaper.
The requirement to report the green component of an investment portfolio stems from the EU Sustainable Finance Action plan. Asset managers must indicate within the European Sustainable Finance Disclosure Regulation (SFDR) which class their fund belongs to - for sustainable funds, this is SFDR article 8 or 9.
Hadewych Kuiper, managing director, has no doubts about the objectives of EU regulation. “At Triodos Investment Management, we embrace European regulation. We are in favour of the regulation being in place and endorse its objectives of transparency for investors and, above all, more capital towards sustainable companies,” she said.
Social taxonomy still not addressed
She pointed out that there are some shortcomings and said the EU taxonomy is far from complete. “People have started to define only part of the green and sustainable part while social taxonomy is not addressed. This is extremely important for building a sustainable society.”
But the intention is there and a draft proposal is already on the table. Social aspects however are much more difficult to define than green and it is not always easy to reach a compromise in Europe. “We nevertheless believe it is important that the financial sector is also encouraged to invest in things that have a social impact,” said Kuiper.
The definition of certain environmental activities is not yet complete and the social taxonomy is only at the development stage. “This can lead to significant misrepresentation if we have to indicate what percentage of a portfolio is sustainably invested according to the EU taxonomy,” said Nikkie Pelzer, Triodos IM’s impact manager.
Consequently, it is implied that from January next year, a fund’s sustainability score can not yet accurately reflect the true sustainability nature of a fund, added Kuiper. “There is still a lot of work to do on the EU taxonomy but we should however see this as the first steps in a long-term development.”
Owning fossil fuels risky
Kuiper also highlighted a more fundamental problem. ”We were strongly in favour of the taxonomy being based on purely scientific climate research. Scientists have been very clear: nuclear energy and gas do not belong in the list and only have a role in the energy transition. Europe has unfortunately decided otherwise because there are now big interests in nuclear power and gas. As these two activities fall within the sustainable framework of the EU taxonomy. Funds investing in gas and nuclear could now score higher than truly sustainable funds. Is that really the intention.”
Asked about the oil’s recent comeback as an investment, Kuiper and Pelzer said that having a portfolio with fossil fuels implies a significant risk. “Too many investors believe today that oil is yielding well so they are investing in it again. However, we have a long-term vision of what a sustainable society should look like and fossil fuels do not fit into that.”
“Opportunistically turning our cart is therefore not part of Triodos’ strategy. We explain that to our investors and find that they encourage us to stick to that long-term strategy. But make no mistake, the risk of having fossil assets in your portfolio today is not minor. In the long run, they can become so-called stranded assets that can suddenly be worth very little. This scenario is currently not being realised but the risk is very significant.”
Triodos, said Kuiper, invests time in working groups around regulations so that such opportunistic behaviour can eventually be curtailed. At the same time, she is positive that inflows into SRI funds covered by Article 9 increased in the first half of the year, while otherwise a solid outflow was recorded. “Surely clients and advisers are more likely to gravitate towards the most sustainable funds.”’
‘Impact/risk/return’
The Triodos IM team pointed out that today’s financial sector still thinks mainly in terms of “risk/return”, instead of “impact/risk/return”.
“It should be a three-way split and positive as well as negative impact should be looked at. Only then as an asset manager will you give a real picture to your clients. And for sustainable funds, there are a lot of such obligations within the EU-SFDR. Calculating the negative impact, for instance, is well defined, via 14 mandatory indicators that each sustainable investment in companies, governments and real estate in Europe must indicate. You can define the positive impact yourself but you have to disclose your methodology and publish the figures.”
Article 6 cheaper
The costs for sustainable funds, such as those defined under Articles 8 and 9 of the SFDR, are increasing due to all the additional reporting requirements.
“’However, the problem is that these funds are put at a competitive disadvantage compared to conventional funds covered by SFDR Article 6,” they said. “Some asset managers therefore prefer to classify their sustainable funds under Article 6. Again, that cannot be the regulator’s intention.”
At Triodos Investment Management, they believe that at least the lower limit of the legislation - being transparent about the broad, negative impact of a portfolio on people and the environment - should be made mandatory for all mainstream funds.
“To be fully transparent, there should also be a brown taxonomy on which all financial market participants should report. All investors should know whether their investments cause serious harm to people and the environment,” Pelzer concluded.
This interview originally appeared on Investment Officer Belgium.