In responsible investing there is a strong push toward more outcomes-focused approaches - investors are being asked how they use their investment and stewardship powers to drive sustainability outcomes at companies and in the real world.
In this blog post, we look at growing stakeholder expectations, the regulatory setting and provide guidance for the demonstration of achievements.
“Stewardship has the greatest meaning when it directly relates to practical outcomes, and not just a policy framework” - ICGN Global Stewardship Principles.
Reflecting a natural progression of the industry, the truth is however that we’re still in quite a nascent state of assessing environmental and social impacts. While there are significant regional differences, the current environment is much characterised by a lack of standardisation leading to subjective interpretations and the pushing of boundaries.
This failure to adequately self-regulate has alerted the attention of regulators who have implemented a plethora of sustainable finance policies in recent years, while getting serious about greenwashing. But to implement robust, transparent, and comparable evaluation processes requires more institutional innovation and the standardising of rules and norms (read: CSRD, SEC mandatory climate disclosures, ISSB, etc.).
ESG disclosures provide an important mechanism for benchmarking, accountability, and behavior. As explained by George Serafeim in a working paper, this focus might be desirable to mitigate ‘cheap talk’ by companies, as a company would need to show real effects (e.g., reductions in carbon emissions, improvements in lost time injury rates) instead of disclosing the adoption of a policy or initiative that might generate no real effects.
Conceptually, this looks similar for both investors and investees, however their respective impacts are different, so it makes sense to separate the two. Zooming in on Europe, we find that the EU sustainable finance rules are poorly designed in regards to such theories of attribution. Per the 2DII analysis ‘Fighting greenwashing… what do we really need?’, while the SFDR and the Taxonomy Regulation require that certain investments demonstrate a positive impact of the investee company (e.g. to be marketed as Article 9), there is no requirement to demonstrate the positive environmental impact of the investor (or the purchase of the financial product).
//For information on active ownership expectations in the SFDR (including the principal adverse impacts) and the EU Taxonomy, please read this blog.//
Here’s a quick recap of the well-known concept between investor and company impact:
Investor impact can be defined as the change that the investor causes in the activities of real-economy actors (most often the investee company)
Company impact on the other hand is the change that the company has caused in the real economy.
In other words, investor impact can be referred to as the change that investor activity achieves in company impact, and company impact as the change that a company’s activities achieve in a social or environmental parameter.
There are general finance rules (MIFID II, CBDF Regulation and Prospectus Regulation) that also apply to environmental impact claims in the finance sector, although these rules are perceived as too high-level to provide effective governance of such claims. Then there’s also the UCPD Guidance and MDEC Principles, the latter a soft law initiative representing recommendations from a multi-stakeholder dialogue on environmental claims (MDEC) in relation to how the general UCPD provisions apply in the context of environmental claims. Even so, remember that while EU-level regulation seeks to provide a minimum level of harmonisation, differences between the national rulebooks should be considered.
In a separate blog, we highlighted disclosure requirements from both ICGN and the UK Stewardship code. As with the PRIs guidance, due weight should be placed on quality and evidence-based engagement focusing on clear outcomes. With this and the regulatory setting in mind, as impacts may not be immediately quantifiable, or comparable, it’s extra important to let honesty and realism guide your outcomes-focused disclosures. You can still provide qualitative and quantitative reporting on the progress of your engagement efforts, including making use of longer and shorter-form narratives, and case studies. For the latter, - unless anonymising - best practice would have you corroborate narratives with the targeted entity for verification of the engagement journey and outcomes, which will increase your credibility, even if additionality is hard to claim.
Furthermore, we suggest you take a look at the aforementioned 2DII analysis here as well, which provides suggestions for the development of guidance for responsible environmental impact claims in the finance sector. It covers aspects such as reality-based claims and substantiating those, providing transparency on additionality, and the limits of products.
Lastly, Esgaia’s engagement management software can act as an enabler here. Importantly, it helps ensure complete data trails of interactions, and offers flexible progress monitoring through e.g. objectives and milestones. In turn, all inputs, including any linked SDGs, PAIs, and engagement outcomes trickle through to a statistics tab to support stakeholder reporting across entity, product and engagement level.
//The Esgaia Team