Insight Investment’s Joshua Kendall, the firm’s head of responsible investment research and stewardship, falls amid the critics of the EU rules surrounding the Sustainable Financial Disclosure Regulation (SFDR), and shares his ideas on how the taxonomy can be improved.
SFDR launched in March – what have been the clear advantages and disadvantages that have come to light since then?
Phase one of SFDR to introduce categorisation of strategies and portfolios into three pillars has encouraged welcome standardisation across the industry. However, these pillars are very simplistic and do not capture the range of approaches available to investors, which may have unintended consequences.
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In Phase two, the Regulatory Technical Standards (RTS) are aiming to establish standardisation in metrics and reporting. The greatest challenge currently is that companies are not yet obliged by law to disclose the information pertinent to RTS reporting. Also the metrics can tend to have too much of a ‘one size fits all’ approach. For example, they lean towards blanket reporting on issues such as sovereign carbon intensity, but this approach champions countries that are already managing this issue well, leaving the possibility that investment is driven to countries that need it the least.
Where are there still areas of confusion?
There is a general perception, at present, that if a product is not Article 8 or Article 9 it has no ESG process. This is an over-simplification which misses important nuances.
An Article 6 product, which is any investment strategy that doesn’t have sustainability as a core objective, might have sophisticated techniques for managing ESG risks integrated within its overall risk management approach, including stewardship, but still not qualify for Article 8. Meanwhile, Article 8 status can be achieved by bolting on elements of exclusion criteria, which may not be meaningful.
How can the Regulatory Technical Standards within the Sustainable Finance Disclosure Regulation better reflect different asset classes and regions?
There needs to be more focus on fixed income and its sub-asset classes. For example, there is no reference to structured finance in the RTS and therefore no expectation for reporting on these investments.
There’s also limited reference to sovereign investments. Sovereign debt is a very significant and complex sub-asset class of fixed income. When you consider how involved a sovereign is in every aspect of communal life, it’s very evident that they need to be factored in as the RTS evolves.
Should RTS reporting becoming mandatory? Why? What impact will this have on how you run portfolios?
The RTS reporting is already mandatory for Article 8 and 9 strategies. The EU reporting requirements should sit alongside more granular definitions of sustainability set by the fund managers directly.
We expect the majority of RTS metrics not to influence portfolios because the metrics themselves do not apply to most portfolio holdings. The exception is carbon intensity, where there is good data available and Insight already applies this into portfolios.
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Is there a risk of some regions or asset classes being overlooked in current format?
While there is merit in aiming to establish comparable metrics and to provide standardisation in reporting, the next evolution of RTS could better reflect the diversity of asset classes, geographies and countries in scope.
How should the green bond market be aligned with SFDR?
The EU could make greater reference to the guidance already set by ICMA, which is seen as the gold standard and is the result of market participants working together to develop best practice.
What else would you like to see come out of the legislation in the future?
The legislation has been beneficial. It’s now set but, where there is scope for evolution, we would like to see greater reflection of the complexities of fixed income as an asset class and more consultation with market participants.
Any thoughts on the Taxonomy?
Investors need a common language for green investment activities. An effective taxonomy creates a framework that can support investors in their engagement and reporting activities by guiding and standardising issuer disclosure.
