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The Global Convergence of ESG and Public Affairs

Having emerged first in 2005, today Environmental, Social and Governance (ESG) factors are increasingly considered as an important part of the analysis and decision-making process around responsible investments. Similar concepts such as the ‘triple bottom line’ have been around much longer but growing societal concerns about climate change, inequality and social injustices and transparency, particularly among the younger generations, have propelled ESG investing to over $20 trillion in Assets Under Management, according to a July 2018 Forbes article.  This reflects the fact that many investors as well as financial institutions feel a responsibility to be more selective in their investments, and see ESG factors as drivers of economic value.

Inevitably, to guide investors and other market operators, this development created the need for definitions, categories and criteria as to what qualifies as a responsible investment for the ESG analysis. In early 2005, the then United Nations Secretary-General Kofi Annan invited a group of the world’s largest institutional investors to join a process to develop the Principles for Responsible Investment (PRI). A 20-person investor group drawn from institutions in 12 countries was supported by a 70-person group of experts from the investment industry, intergovernmental organizations and civil society. The PRI developed six principles (https://www.unpri.org/pri) to which its now 2,000 signatories from over sixty countries adhere. According to PRI, the number of signatories has grown rapidly, especially over the last five years, representing over $80 trillion in assets in 2018.

The 2015 Paris Agreement on climate change and the UN 2030 Agenda for Sustainable Development have been important additional political drivers for this trend. As a long-time proponent of progressive climate change policies and public policies to organize markets, the EU did not take long to respond. At the end of 2016 the European Commission created a High-Level Expert Group on sustainable finance, which published its recommendations in January 2018. Two months later the Commission presented a comprehensive Action Plan on sustainable finance.  According to the Commission, current levels of investment are not sufficient to support an environmentally and socially sustainable economic system. It said that “Europe has to close a yearly investment gap of almost EUR 180 billion to achieve EU climate and energy targets by 2030.10 According to estimates from the European Investment Bank (EIB), the overall investment gap in transport, energy and resource management infrastructure has reached an astounding yearly figure of EUR 270 billion.” The Commission argued that a lack of clarity among investors regarding what constitutes a sustainable investment was a contributing factor behind this investment gap and also an obstacle to financing the social infrastructure that is needed to address inequality and inclusiveness issues.

In what can be considered warp speed in the European Commission bureaucracy, in May 2018 the Commission presented three legislative proposals and a long range of non-legislative initiatives to provide more clarify. It proposed a unified EU classification system – or taxonomy – to provide clarity on which activities can be considered ‘sustainable’ at an EU level (to avoid an increasing number of myriad of national rules in European countries) and which would form the basis for using that classification system in different areas (e.g. standards, labels, sustainability benchmarks). The other two proposed Regulations would set the rules for disclosures and carbon benchmarks. With a view to reaching agreement on this package before the European Parliament elections in May 2019, the EU institutions have been pushing the proposals through the legislative process. Most of the debate has centered around the level of detail and scope of the legislation. For example, the European Parliament is arguing for the inclusion of harmonized environmental indicators that should form the basis of the criteria. The European fund and asset management industry has broadly welcomed the Commission’s proposals but cautioned against a prescriptive and narrow approach which would create unintended consequences on the development of the sustainable investment market in Europe.

EU Member States and the European Parliament have already reached agreements in principle on the disclosure and carbon legislation, whereas negotiations continue on the proposed taxonomy. But even if the package of primary legislation ends up being adopted in the next few months, much of the detail and implementing rules will be developed in the next few years. This will present ample opportunities for the private sector to provide its technical expertise. For example, the European Commission is proposing the creation of Platform on sustainable finance. This Platform should be composed of experts representing both the public and the private sector, such as the European Environmental Agency, the European Supervisory Authorities, the European Investment Bank, financial market actors, universities, research institutes and trade associations. The Platform should advise the Commission on the development, analysis and review of technical screening criteria, including their potential impact on the valuation of assets.