Sustainability | ~ 3 min read
How sustainable is your investment?
Defining sustainable investments has been a persistent challenge for the industry. Regulatory developments have added to this challenge by providing a general definition while leaving the door open for different interpretations.
According to the European Union’s Sustainable Finance Disclosure Regulation, or SFDR, an investment must satisfy three criteria to qualify as “sustainable”:
- The economic activity of the investment must provide a positive contribution to an environmental or a social objective.
- The investment does not significantly harm any other environmental or social objective.
- The investee company must follow good governance practices.
Since the introduction of SFDR in 2021, there has been uncertainty across the investment industry, particularly about the interpretation of the notion of “sustainable investments”. Divergent interpretations have appeared in the market, which can be clustered into two main approaches:
- Activity-based: the percentage share of a company’s revenue from positively contributing activities is considered its sustainable investment share, provided the “Do No Significant Harm” principle and good governance criteria are satisfied. For example, ABC Energy Company, with a split of 30% revenues from renewable power generation and 70% from non-renewable power generation, would have a 30% sustainable investment share.1
- Company-level: here the sustainable investment assessment is binary – yes or no – and is determined by an investment manager’s in-house methodologies and assumptions. Typical methodologies consider one or more of the following elements: a minimum percentage sustainable revenue share, a net-zero commitment, a top ESG2 score performance or a specific key performance indicator. Using the same example, an investment in ABC Energy Company might be classified as a “sustainable investment” because at least 20% of its revenue is from renewable power generation.
The European Commission confirmed in its SFDR Q&A that the definition of ”sustainable investments” is non-prescriptive, and that investment firms must carry out their own assessments and disclose their underlying assumptions.
Our view
We applaud the motivation behind the overarching regulatory initiative, but we think the opportunity for creating a market standard for such an important assessment has been missed by the European Commission. While this may increase the potential for innovation in sustainable strategies, it could limit funds’ comparability for clients.
We believe that an activity-based approach is more accurate and allows us to integrate our internal sustainability convictions into these assessments. Our proprietary methodology draws on in-house research expertise across our key themes of climate change, planetary boundaries and inclusive capitalism. Additionally we leverage the EU Taxonomy targets and the UN Sustainable Development Goals as guidance for the definition of our internal standards.
This methodology provides our investment professionals with a powerful tool to support clients in achieving their sustainability objectives by identifying companies that contribute to a more sustainable future.
