The sustainable investing market is witnessing remarkable growth: since 2018, annual cash flows into sustainable funds have increased tenfold. Now, more than ever, investors and asset managers alike seek sustainable products and strategies offering robust financial returns. The field, however, has been haunted by greenwashing claims and a lack of consistency in identifying what, exactly, makes an investment “sustainable”.
Sustainability or “green” taxonomies developed by governments, international bodies and non-governmental organizations (NGOs) can help resolve these challenges and inconsistencies by identifying specific assets, activities or projects that meet defined thresholds and metrics that quantify sustainability. These systems can cover the full spectrum of sustainability topics, from achieving acceptable levels of greenhouse gas emissions to compliance with certain human rights standards. Among other benefits, sustainability taxonomies can:
- assist investors, asset managers and asset owners in identifying sustainable investment opportunities and constructing sustainable portfolios that align with taxonomy criteria;
- drive capital more efficiently toward priority sustainability projects;
- help protect asset managers against claims of greenwashing by providing an independent benchmark for the sustainability performance of investments; and
- guide future public policies and regulations targeting specific economic activities based on taxonomy criteria.
In this series of Blog Posts, we first provide a brief overview of some of the key existing and developing taxonomies around the world. We then set out our analysis of the ways asset managers are already leveraging taxonomies in their businesses based on a review of publicly available responsible investment reports. Finally, we highlight certain challenges that asset managers may encounter as these systems develop and interest in sustainable investing continues to grow.
Sustainability taxonomies have a wide range of applications, from informing public policy and regulation to efficiently allocating capital toward sustainable projects. But how are asset managers practically applying these new systems in their businesses?
To answer this question, we reviewed a sample of public responsible investment reports published by asset manager signatories to the United Nations Principles for Responsible Investment (UNPRI). UNPRI signatories commit to incorporating ESG issues into their investment practices and reporting on their responsible investment activities on an annual basis. Together, these reports provide valuable insights into the current state of sustainable investment practices around the world.
Based on our review, asset managers are already applying taxonomies in the following ways:
1. Integrating taxonomy criteria into investment selection processes
Asset managers are integrating the taxonomy criteria used to define certain activities as “sustainable” into their investment selection processes, including due diligence. Managers may generally refer to taxonomy criteria as a guide when developing their own bespoke, internal sustainability taxonomies or more directly apply thresholds and metrics as they are set out in a taxonomy.
For example, one manager has generally referred to the EU Taxonomy to establish its own investment categorisation and due diligence processes, but does not commit to applying the taxonomy or its metrics in specific ways. Another manager takes a more specific approach and has committed to only invest in companies or assets that generate 50% or more of their annual turnover from activities identified in the Green Fin Label taxonomy.
2. Defining metrics and methodologies for monitoring and reporting purposes
Asset managers are using taxonomy criteria to enhance ESG and sustainability-related monitoring and reporting to asset owners. Taxonomy criteria are used to set transparent KPIs to track, measure and report on sustainability topics, such as greenhouse gas emissions, on a portfolio-wide or an investment-specific basis. The resulting data can also be used to develop ESG or sustainability work plans for portfolio companies to improve performance on key topics.
For example, one asset manager tracks and reports both portfolio-wide CO2 emissions and the percentage of AUM invested in sustainable economic activities as defined in the EU Taxonomy. Another tracks the carbon and environmental footprint of all portfolio companies and assesses their position against the EU Taxonomy.
3. Developing new taxonomy-aligned funds, investment strategies and policies
Asset managers are taking advantage of the unprecedented interest in sustainable investment and strategically launching new products incorporating taxonomy criteria from the outset. New funds may be marketed as sustainable based on investment strategies and policies aligned with one or more taxonomies.
For example, one asset manager is now developing a sustainable fund with a “minimum EU Taxonomy eligibility target” that will focus on “certain sectors which are EU Taxonomy compliant.” Another is promoting a fund’s investment strategy, which focuses on certain environmental objectives found in the EU Taxonomy, as having “strong investment alignment to the activities defined under the EU Taxonomy”.
Our analysis also shows that many asset managers are actively engaging with governments, other private sector players and international organizations through public policy avenues to join and guide the conversation as taxonomies rapidly develop. These avenues include participation in trade association working groups, consultation responses and direct engagement with public sector bodies.
In Part III, we will set out some of the taxonomy-related challenges that asset managers may encounter as the leverage these new systems.