Maintain the level of ambition across sectors
When discussing climate finance, it is good to start by remembering investors cannot do the job alone. Reasserting the current target of limiting global warming to 1.5°C by 2050 at COP28 and rolling out ambitious and consistent policies across sectors to achieve carbon neutrality are pre-requisites to mobilise capital and generate climate investment opportunities, writes Arthur Carabia director of ESG policy research at Morningstar Sustainalytics.
In that sense, the EU Green Deal and the US Inflation Reduction Act are pivotal, long-term catalysts that positively support the transition. There should be no hesitation in implementing these plans and related policies. We already know more needs to be done to fully meet the objectives of the Paris Agreement.
While many companies have been enthusiastic in pledging their alignment to net zero by 2050, only a handful are on track, according to Morningstar Sustainalytics’ Low-Carbon Transition Ratings. With most corporates lagging, it is no surprise to see additional policies being rolled out, such as the EU Corporate Sustainability Due Diligence Directive, which intends to require approximately 17,000 companies to adopt a transition plan.
No time to get cold feet on climate-related disclosures
As companies shift towards more sustainable business models, investors need access to relevant information to evaluate climate-related risks and opportunities, keep track of progress and hold polluters accountable when required. While the pool of climate data is growing, the Task Force on Climate-Related Financial Disclosures recently revealed only 4% of companies disclosed in line with all 11 principles it recommended.
The evolution of the policy context on disclosures is a mixed bag. Leading the pack is the EU, with its Corporate Sustainability Reporting Directive – which mandates climate-related disclosures (ESRS E1) with reports due in 2025. In the US, the SEC’s rulemaking is supposed to be imminent but there is serious doubt Scope 3 emissions will be covered.
The International Sustainability Standards Board’s (ISSB) climate standards have yielded mixed results. Although initially eagerly supported by G20 countries, it is disappointing to see some states announce delayed timelines to endorse and enforce this initiative. For instance, the UK and Japan’s timeline means the first climate report issued by corporates will be in 2026 at best.
Government-level action on the standards may be falling short, but the hope is some issuers will lead the way. After all, companies do not have to wait for the endorsement of ISSB standards by national jurisdictions and can directly claim compliance with the standards via an audit. What is certain is investors cannot afford to wait and will continue to use estimation models if needed.
Perfect is the enemy of good
Although regulatory bodies and standard setters seek to fulfil various remits, a common aim is to combat greenwashing. While these efforts should in theory improve the efficacy of climate efforts, paradoxically, the anti-greenwashing agenda has distracted investors from the climate transition goal.
In the EU, the three main regulatory data points of the EU Action Plan meant to enhance transparency, compare products, and fight greenwashing (Taxonomy, Sustainable Investment, Principal Adverse Impact indicators) have proven difficult to implement and complex to grasp for retail investors, rendering the comparison of financial products difficult and sometimes unreliable.
The EU taxonomy is one well-intended element with limited practical applications. As the framework mainly focuses on climate adaption and mitigation activities, it is difficult to use in the context of global asset allocation given the use of estimated data is discouraged by supervisory guidance. As a result, climate funds often report 0% or highly conservative figures for fear of litigation.
The successive declassification and reclassification of EU Paris-Aligned Benchmark funds from Article 8 to 9 categories, due to evolving regulatory guidance, also highlights that in some instances we have lost sight of the main prize. The European Commission’s Sustainable Finance Disclosure Regulation review, taking place until the end of the year, is an opportunity to unambiguously put climate transition disclosures back centre stage. It is also a chance to broaden climate disclosure to all products and against benchmarks, because so far, disclosures are exclusively required for sustainable funds and without a point of comparison.
Huge headway has been made in climate policy in recent years, but the regulatory landscape still needs major improvements. In the meantime, corporates cannot afford to blindly rely on top-down directives or ‘wait and see’ what COP28 delivers as laggards will be increasingly penalised by investors.
This article was written for International Adviser by Arthur Carabia director of ESG policy research at Morningstar Sustainalytics.
