Sustainable investment, responsible investment or ESG investment: what’s the best term to use? Today, we are talking about 'responsible investment': investment that explicitly acknowledges the importance of the environment, social issues and good governance. We also follow new European regulations that reserve the term 'sustainable' for a specific number of activities and products.
What is responsible investment?
Responsible investment funds invest in companies and countries which that embrace the ESG themes of Environment, Social and Governance.
This specific focus does not mean that you have to compromise on your returns. Research shows that social and financial returns can go hand in hand: funds that invest responsibly provide similar long-term returns to traditional funds.
Finally, responsible investment means you have an impact on the business world. KBC you enter into a dialogue with the companies in which you invest and help to determine their course through the exercise of voting rights at general meetings.
What is ESG?
In the pursuit of a greener and more sustainable economy, the financial sector must also make a significant contribution to meeting European targets. This ambition focuses on environment, society and good governance, also known as ESG. ESG stands for ‘Environment, Social & (good) Governance’.
This ambition is regulated by legislation including the EU Taxonomy Regulation and the Sustainable Finance Disclosure Regulation (SFDR).
Why is ESG so important?
ESG is a tool and framework that is used to strike a balance between financial and economic performance, transparency, social interests and the environment. Contrary to popular belief, it turns out that this balance leads to better results for both the company and society. There is a broad consensus that ESG objectives ultimately create added value for portfolio companies, both in terms of risk mitigation and value creation.
What is ESG in IID?
As part of its commitment to sustainable investment, the EU has proposed changes to the IID suitability rules to ensure that investors' environmental, social and governance (ESG) preferences are taken into account during investment advice and portfolio management.
This means that you can indicate to what extent you wish to invest in:
• Socially responsible investment (SFDR) As an investor, you can determine the minimum percentage of sustainable investments that the financial products (which KBC recommends to you) must contain.
• Ecologically sustainable investments (EU Taxonomy). As an investor, you can determine the minimum percentage of environmentally sustainable investments that the financial products (which KBC recommends to you) must contain.
• Financial instruments that take into account adverse effects on sustainability factors (PAI). As an investor, you can choose environmental and social themes, ensuring that your investments limit the adverse impacts on sustainability factors within these themes.
What is SFDR?
SFDR stands for Sustainable Finance Disclosure Regulation.
Sustainable investments as definied in SFDR are investments in economic activities that contribute to an environmental objective, for example limiting the use of fossil fuels, or a social objective, for example a gender-neutral wage policy.
In addition, the contribution of an economic activity to one target must not undermine the other targets.
SFDR also defines what constitutes a 'sustainable investment':
• An environmental objective (E) as measured, for example, by key resource efficiency indicators on the use of energy, renewable energy, raw materials, water and land, waste generation and greenhouse gas emissions, or by the impact on biodiversity and the circular economy, or which contributes to this;
• A social objective (S), such as combating inequality or promoting social cohesion, social inclusion and labour relations, or an investment in human capital or in economically or socially disadvantaged communities;
• The condition is that the investments do not have a significant adverse impact on any of these objectives and that the investee companies follow good corporate governance practices (G), particularly in relation to sound governance structures, employee relations, compensation of staff and tax compliance.
What is the point of SFDR?
SFDR is a European regulation aimed at ensuring the transparency and comparability of ESG information for end investors in order to minimise greenwashing. In practical terms, this means that producers and advisers have to provide a lot of 'entity level' information on their public websites. For products (funds, managed products, models), this means that additional information must be added to pre-contractual documents and periodic publications.
How does SFDR classify funds?
A distinction is made between three different types of funds, namely:
• Article 6: Conventional funds, which do not promote ESG characteristics or cannot calculate them.
• Article 8: Funds promoting environmental or social characteristics: all funds that promote a combination of environmental and/or social characteristics.
• Article 9: funds with a sustainable investment objective: all funds that have a sustainable investment objective and whose concrete contribution to this objective can be measured and reported.
What is EU Taxonomy?
The EU Taxonomy is a classification system for determining which economic activities are environmentally sustainable. Environmentally sustainable investments must contribute substantially to one of the six objectives of the EU Taxonomy Regulation:
• The protection and restoration of biodiversity and ecosystems;
• Climate change mitigation;
• Pollution prevention and control;
• Climate change adaptation;
• The transition to a circular economy;
• The sustainable use and protection of water and marine resources.
Moreover, they must not adversely affect any of the other five environmental objectives.
Why is there an EU Taxonomy?
With the Green Deal, the EU has set itself the goal of becoming the first climate-neutral continent by 2050. The EU also has objectives for other environmental themes.
In order to achieve these objectives, the EU has drawn up an action plan aimed at channelling funding towards sustainable investments. As part of this plan, the EU wanted to provide a definition of ‘sustainable’ and ‘green’: a taxonomy.
This makes it clear to everyone which projects/investments are actually very sustainable and which projects are not ambitious enough to be called 'sustainable' or 'green'. The EU Taxonomy will hopefully also bring about an end to ‘greenwashing’.
Wikipedia defines greenwashing as the pretence by a company or organisation to be greener than it actually is. It acts as if it is pursuing carefully considered environmental and/or other societal themes, but this often turns out to be little more than a ‘lick of paint’.
Who does the EU Taxonomy apply to?
Companies will be required to report what proportion of their activities and investments are environmentally sustainable according to the EU Taxonomy. This will increase transparency and prevent greenwashing, as the definitions in the Taxonomy must be used.
Financial institutions like KBC will have to report how many sustainable activities they finance, for all their activities. In practice, this means that KBC will have to report what percentage of its credit, insurance policies, funds, etc. comply with the EU Taxonomy. This requires specific data, which differs for each activity.
How does the EU Taxonomy work in practice?
The Taxonomy evaluates an activity (e.g. an investment project or business activity) on the basis of the six environmental objectives, which are shown in the adjacent figure.
In order to be considered ecologically sustainable, an activity must simultaneously fulfil three requirements:
• Makes a substantial contribution to one of the six environmental objectives;
• Does not seriously undermine other environmental objectives (Do No Significant Harm);
• Complies with minimum (social) guarantees.
The criteria are not yet fully developed and companies are not yet required to report their Taxonomy compliance rate. As a result, the data available on the market is very sparse and often unreliable. This will improve in the future.
Sustainability factors (PAI)
Investments with adverse impacts on sustainability factors (Principal Adverse Impacts, PAI)
Economic activities can have not only a positive, but also a negative impact on sustainability factors. Principal Adverse Impacts (PAI) refer to the adverse impact of investment decisions on sustainability factors such as the environment, social issues, respect for human rights and anti-corruption.
Starting on 1 January 2023, KBC will report which adverse effects on sustainability factors are avoided within its funds.
What is the purpose of adverse effects on sustainability factors (PAI)?
In general,the European Commission hopes that customers and investors will use this information to select the companies from which they wish to purchase products or services, and that they will focus on companies which seek to minimise adverse impacts on sustainability factors.
It is also hoped that this will have a ‘trickledown’ effect, i.e. provide a strong commercial incentive for underlying investee companies and product providers to adopt the kind of ‘standards’ that the Commission would like to see widely applied in the areas of climate change, diversity, anti-bribery, etc.
What indicators are there within PAI?
The adverse effects on sustainability factors are broken down into nine different sustainability themes:
Published by companies:
o Greenhouse gases
o Social affairs and employees
Issued by countries and supranational institutions:
With underlying real estate component:
o Fossil fuels
o Energy efficiency
A set of 18 mandatory indicators has been devised under these themes.
Responsible investing with KBC
Towards Sustainability-label Febelfin
All KBC funds that invest responsibly carry the label 'Towards Sustainability', an initiative of Febelfin. This means that the funds follow a clear sustainability strategy, exclude very harmful or activities and have a transparent policy on socially controversial practices such as the death penalty.