Article 9 of SFDR: the new green lodestar?

My ESG?Viewpoint published yesterday in IPE:

[https://www.ipe.com/esg/esg-viewpoint-article-9-of-sfdr-the-new-green-lodestar/10061862.article]

Regrettably, the EU’s Taxonomy for Sustainable Activities has gone from proposing “real change” to “may be imperfect”. These are the polite words of EU financial services commissioner Mairead McGuinness herself. Less politely, Greta Thunberg judged that the Taxonomy simply “takes greenwashing to a completely new level [since t]he people in power do not even pretend to care anymore”. They just label fossil gas as green and nuclear waste as pollution controllable over the next hundred thousand years.

According to the Washington Post, “Andreas Hoepner, a professor at University College Dublin who was part of an expert group that advised the EU on the taxonomy, likened the plan to ‘calling french fries salad.’”

Andreas Hoepner, that is me. In my view, the Taxonomy has gradually been slipping into a civil lobbying war zone between proponents of the first delegated act led by the UN PRI’s chief responsible investment officer Nathan Fabian and proponents of the second delegated act schemed by Pascal Canfin, a French MEP from Macron’s party and former WWF France CEO.

While the Fabian delegated act remains excellent guidance for bond issuance and bank lending worldwide, the Canfin version has resulted in the EU taxonomy having less scientific thresholds in the energy sector than the South African equivalent, which was developed based on the Fabian text .

In my very personal words, the developed economies’ well developed energy greenwashing narratives which found their way into the Canfin version have ironically led to its taxonomy being scientifically less developed South Africa’s ‘copycat’.

While supporting the Fabian delegated act in its civil lobbying war, scientifically conscious stakeholders are intensely scouting for a new ‘green lodestar’ to associate their personal intergenerational hopes and organisational development processes with.

I personally believe that Article 9 of the Sustainable Finance Disclosure Regulation, aka SFDR, is very well suited to take up this role and I will explain the intricacies of SFDR in a new monthly column for IPE.

Most importantly, SFDR is not an ‘eco-label’. It is just a disclosure regulation which mandates minimum standards for those wishing to disclose their sustainability credentials in the most ambitious levels, the so-called Article 8 (second tier) article9 (first tier).

According to Alain Deckers, head of the relevant unit in the EU’s Directorate-General for Financial Stability, Financial Services and Capital Markets Union (DG FISMA) “#Article9 claims to be walking the walk, #Article8 claims to be talking the walk [and] #Article6 you have to do it whether or not you are talking or walking”.

Actually ‘walking the walk’ represents a fundamental paradigm shift in regulated disclosure ambition for three reasons. First, sustainable funds have historically too often rested on the marketing friendly side of the universe. Stereotypically, they would promote themselves as a certain percentage better than benchmark say in term of greenhouse gas emissions but never committed to improve themselves year on year.

This resting place was sufficiently progressive for the marketing needs of product managers while being likewise considerably relaxed in terms of the strategic demands on portfolio managers. From a planetary impact perspective, however, it meant that if the benchmark emissions rose in a given year, so did the ‘sustainable’ fund’s emissions, just in overall lower numbers.

Article 9’s ‘walking the walk’ credo now requires the most ambitious of the sustainable funds to move on from their resting place and ensure that their sustainability performance (eg, GHG emissions) are not only better than benchmark in any given year but have also sufficiently improved compared with their own funds in the previous year.

In this sense, SFDR Article 9 serves as pacemaker (walker of the walk), ensuring sufficiently fast sustainability performance improvements of top tier sustainable funds: a true paradigm shift indeed.

Second, the ‘walking the walk’ paradigm shift recognises that achieving real impact outcomes (RIOs) is unlikely feasible for sustainability funds held back by tracking errors associated with broad market indices.

Since these broad market indices sadly do not systematically improve their sustainability performance (at sufficient pace) on most indicators, tying a fund to status quo preserving indices makes ambitious RIO targets a de facto impossibility.

SFDR acknowledges this in Articles 9(1)(a) and 9(3). An alternative complementary approach would be a switch from tracking error to trailing error. (Both approaches will be explained in more detail in future columns.)

Third, representing a disclosure legislation instead of a label, SFDR ingeniously shifts the legal responsibility from third party rating/labelling agencies to the internal legal and compliance teams of institutional investors.

This paradigm shift in responsibility is intended to inject a stronger focus on the UN’s precautionary principles into organisational decision making, as it substantially hinders a key model in the outsourced greenwashing industry, such as ‘pay to play’ green ratings. Such a paradigm shift may, in fact, also represent a paragon of virtue for corporate disclosure regulation.

Andreas GF Hoepner is professor of operational risk, banking and finance at University College Dublin and serves as head of the data subgroup on the EU’s Platform on Sustainable Finance?