When it comes to green finance, the United Kingdom often sticks to the EU agenda, but also comes up with refreshingly different approaches. What can we learn from the country that claims global leadership in green finance? An approach in three parts.
The question of how the challenging topic of sustainable investment can be communicated as transparently, understandably and needs-based as possible is also a concern for experts in the UK. The Disclosures and Labels Advisory Group (DLAG), which is based at the UK Financial Conduct Authority (FCA), has therefore published the discussion paper Sustainability Disclosure Requirements (SDR) and investment labels. It builds on the Green Finance Roadmap and has prompted discussions within the FCA, as revealed in the paper Matter of fact sheets from October 2022.
In the discussion paper, the UK Financial Conduct Authority (FCA) explores proposals by the DLAG for different categories of financial products regarding sustainability. The following four are proposed:
- No sustainability label: Products that do not meet the criteria for a sustainability label
- Sustainable alignment: Investments in assets that are environmentally and/or socially sustainable
- Sustainable improvement: Investments in assets that improve over time, including in response to stewardship activities
- Sustainable impact: Investments in assets that provide solutions to environmental or social problems with an explicit objective to achieve a positive, measurable impact
According to the paper, the categories should not be seen in a hierarchical relationship to one another as this would be difficult to visualise. Rather, they should serve to reflect the different preferences of consumers and generally consider the fact that a standardised answer to the complex issue of sustainable investment is hardly possible.
Different wishes regarding sustainable investments
In fact, preferences among investors vary greatly. According to a survey conducted by the Green Technical Advisory Group (GTAG), 80 percent want their money to have a positive impact in addition to a financial return. 71 percent consider it important to invest their money in a way that protects the environment. Another 71 percent do not want their money to flow into unethical investments.
Preferences in mainland European countries are likely to be similar. The EU has therefore also defined three categories of sustainable financial products for the so-called sustainability issue in financial consulting, which are regulated in the MiFID II and IDD (insurance sector) directives, that may also overlap: Products with a taxonomy component; products with a minimum proportion of so-called sustainable investments; and products that consider principal adverse sustainability impacts, so-called PAIs, via exclusion criteria or exposures.
Complicated and impractical EU regulation
That does not just sound complicated, it is complicated. While the underlying idea of integrating sustainability into financial consulting on a mandatory basis has been met with almost unanimous approval, the actual implementation has evoked a negative response. Even after well over a year of experience with the regulation, frustration remains high.
It is not seen as problematic to use EU regulation as a basis per se – in particular the Taxonomy and Sustainable Finance Disclosure (SFDR) Regulations – but in needing to explain complicated laws in financial consulting as the regulation implies. This is because the tight time frame alone risks important issues being neglected. In addition, the three categories do not optimally support to explain common misunderstandings about sustainable investments – such as the question of why certain securities are in the portfolio.
Sustainability traffic light as a proposed solution from Germany
The German government’s Sustainable Finance Advisory Committee also sees a need for improvement in this area. Its preferred model is a sustainability traffic light with the colours red, yellow and green. As stated in an open letter from the committee in December 2022, the traffic light is intended to increase the transparency of the sustainability features of products and improve comprehensibility in consultations for both advisors and private investors.
However, in view of the consultation on the SFDR, which will continue until 15 December 2023, the proposal from Germany could soon be obsolete. This is because it discusses significant changes that will also have an impact on the requirements for the sustainability issue in financial consulting – specifically the abolition of the two categories that have become known as Article 8 and Article 9 products.
EU Commission draws inspiration from the UK
Interestingly, the EU Commission is debating whether product categories quite similar to the British ones – sustainable alignment, improvement and impact – should be introduced as part of a new proposal. In its proposals, the EU Commission divides the Sustainable alignment category slightly differently into two sub-categories, one of which aims at exclusion criteria and the other at sustainability standards or sustainable topics.
These proposals from the EU Commission are at least well received by the the Dutch Authority for the Financial Markets (AFM): In a position paper, it argues in favour of abolishing the product categories in Articles 8 and 9 of the SFDR and instead introducing three sustainability categories in line with the British proposals.
Sustainable product categories with potential
It may be assumed that the AFM will not be alone in its preference. After all, the UK proposal is characterised by the fact that it takes investor preferences as its starting point rather than existing regulation. Those who do not want to invest in securities that are perceived as unethical can choose products in the Sustainable alignment category. Those for whom impact is particularly important can be recommended the Sustainable impact label, subject to financial aspects. Finally, the Sustainable improvement category can help to make commitment and concepts such as transition finance understandable, which may have the potential to contribute to environmental and climate protection, for example.
The British approach has revived the debate in the EU – with potentially wider implications. And against the backdrop of intense discussions, particularly on the impact of sustainable investments, new opportunities, but also challenges, will continue to arise for financial players. imug rating navigates them on this path in a constantly changing environment by providing support ranging from analysing the portfolio and sustainable investment strategy through to questions regarding sustainability performance and ESG reporting.
Part III will examine the plans regarding green finance in the UK, which, among other aspects, focus heavily on transition finance and the introduction of a green taxonomy as well as regulatory measures for sustainability rating agencies.