The adoption of a universal sustainable taxonomy could significantly improve investment in sustainable assets by giving investors a better understanding of associated risk. As such investments become increasingly mainstream, those that do not adopt such a common approach risk being frozen out of the financial sector.
Speaking at a panel discussion at the Asian Development Bank annual meeting in Tbilisi, Georgia, Joaquín Jugo, co-head of global sovereign solutions for Citi’s public sector group, cited a survey conducted by the bank of 175 non-US investors (whose assets under management ranged between $1bn and $1tn).
The survey found that 38 per cent of investments have an ESG angle, with climate change and energy transition representing the majority of investments. This compares with around 20 per cent a decade ago, he said.
While the change is significant, there are current issues around energy security having an impact on the current scale of investments, Jugo said, but once this is resolved he anticipates there will be increased interest in green investing.
An obstacle he sees now is how to demonstrate that ESG investments are a favourable option. Jugo said while such instruments have a better risk profile from a regulatory perspective, the likes of pension funds are more conservative from a fiduciary perspective. Increasingly, however, the push to sustainability is coming from within the institutions themselves.
“Ten years ago, all of these money managers would basically look at ESG and climate risk and gender as an add-on. Today, the people that are looking into environmental/social risk management are working inside those institutions and are part of the decision making process from the start. This is not going away,” Jugo said.
Key to assisting the adoption of such investments is the convergence of sustainability taxonomies globally, he said.
The International Sustainability Standards Board — the sister board to the International Accounting Standards Board — is hoping that its standards related to sustainability will become mandatory in 114 countries, as is the case with the IASB’s IFRS standards.
Richard Barker, an ISSB board member, said that once sustainability is recognised as fundamental to future economic growth, it ceases to be a distinct area of activity.
“If you only take out an equity valuation model, in that model is some kind of perpetuity growth assumption. It’s actually naive in the extreme to assume that perpetuity growth if we don’t have environmental and social sustainability. It’s an inconsistent assumption,” he said.
There is a growing risk that countries are developing separate sustainability standards in an unco-ordinated manner.
Barker points to the European Financial Reporting Advisory Group standard as being critical in terms of interoperability. The ISSB is to issue a joint guide with Efrag for European reporters also reporting according to IFRS standards.
“This applies to climate more than anything, as it is only in climate where there is a European standard that overlaps with the IFRS rules. The real challenge is not in climate reporting where standards are similar when using the Efrag and IFRS methodologies. The challenge in the medium term is convergence,” he said.
The European standard uses the same definition of financial materiality as the ISSB. This should ensure the same disclosure to investors, making it easier to interpret, he noted.
For companies that are still to begin on their sustainable reporting journey, Jugo cautioned that there is a risk emerging that they are negatively screened.
“If a private sector issuer thinks they can wait it out or it’s too complicated reporting, from both a regulatory and a banking perspective we’ve already seen these companies be negatively screened. Banks are starting to tell companies if I don’t see a transitional programme in place, when your loans mature there is no refinancing,” he said.
“We’ve seen the nice part of sustainability, from making money and helping the environment. Eventually there will be the stick, which is when you will be out of financing options if you don’t get on board.”