01.31.2018
By Shanny Basar

EU Criticises ESG Research

The European Commission’s expert group on sustainable finance said the majority of sellside analysts ignore sustainability and there is insufficient buyside demand for research into long-term and environmental, social and governance issues.

The High-Level Expert Group on Sustainable Finance, which was set up to make recommendations for a financial system that supports sustainable investments, issued its final report today. The European Commission said in a statement that the report will form the basis of its action plan on sustainable finance which will be discussed at a conference on 22 March 2018 in Brussels.

The group said the majority of sellside research analysts continue to focus on a short-term outlook and ignore sustainability issues.

“For example, a recent survey found that a mere 12% of mainstream sellside analysts’ time is spent researching companies’ prospects beyond a 12-month horizon,” added the report.

The study added there is also insufficient demand from the buyside for research into long-term and ESG issues.

“Over 50% of mainstream sellside analysts surveyed are asked less than once a month about broader and longer-term factors, with 12% having never been asked about such factors,” said the report.

AFME, a lobby group for Europe’s wholesale financial markets, said in a statement that it disagreed with the group’s view that sellside analysts do not consider ESG criteria when preparing research.

“Many AFME members have ESG- or climate change-specific analyst teams with many years of experience required to assess the materiality of ESG-related risks to a sector or security,” said the AFME. “Although there is no industry-level best practice on the inclusion of ESG criteria, many firms use their in-house frameworks to integrate such criteria in their research.”

However, overall the AFME said the final report on sustainable finance is a big step in the right direction.

Simon Lewis, chief executive at AFME, said in a statement: “The plans to ease capital charges for banks’ green investments, provided they are commensurate with the risks assumed, can play an important part in the development of a Capital Markets Union. It is crucial that capital markets are geared towards ensuring social and environmental sustainability and we look forward to working with the European institutions to take forward those areas of the HLEG report requiring further discussion and analysis.”

The recommendations in the report include the European Commission and the European Securities and Markets Authority working with investors and the sellside to investigate how they can promote better long-term research in a post-MiFID II world.

MiFID II regulations, which went into force the month in European Union, require payments for research to be unbundled from trading commissions. The report said MiFID II-mandated research disclosures should be amended so all investment firms disclose the proportion of their research budget spent on sustainability-focused research in the past 12 months, whether this is funded from their own P&L or from a research payment account funded by clients.

Asset managers should also develop competence on sustainability and governance issues within their organisations and establish organisational principles and reward structures that encourage long-term oriented behaviour, including incentive structures.

Other recommendations include the Commission convening an  expert group (financial analysts, asset managers, asset owners, insurance companies, banks) to understand precisely how they will use the quantitative and qualitative strategic information generated by ESG disclosures.

“Corporate disclosure on non-financial issues and long-term risks suffers from the lack of responses from potential users,” said the report. “There is a need for capacity-building to avoid disclosure in a vacuum.”

The group argued that reorienting investment flows into long-term, sustainable projects will also improve the stability of the financial system.

The recommendations also include building a classification system, or ‘taxonomy’, to provide market clarity on what is ‘sustainable’; an EU-wide label for green investment funds and a standard for green bonds; making sustainability part of the mandates of the European Supervisory Authorities.

The EU has agreed a 40% cut in greenhouse gas emissions by 2030 and needs €180bn ($224bn) of additional investments a year, including private capital, to achieve this target.

Valdis Dombrovskis, vice-president responsible for financial stability, financial services and capital markets union at the European Commission, said in a statement: “We are now moving towards a low-carbon society, where renewable energy and smart technologies improve our quality of life, spurring job creation and growth, without damaging our planet. Finance has a big role to play in funding a sustainable future.”

Eurosif, the pan-European sustainable and responsible investment membership association, said:

Will Oulton, chairman of Eurosif and global head of responsible investment at First State Investments, said: “The HLEG’s mandate was challenging however with the support of the Commission, the group has developed a comprehensive set of recommendations that can make huge strides in advancing sustainable investment across Europe to the benefit of investors and wider society. Eurosif is looking forward to working with the Commission to deliver on the recommendations published today”

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