Tuesday, 24 July 2018

The role of consumers in supporting sustainable finance

The EU Commission recently took up the task of joining international efforts (the UN 2030 Agenda and Sustainable Development Goals, and the Paris Climate Agreement) in taking due account of environmental (ie. climate change mitigation and natural disasters) and social considerations (inequality, inclusiveness, and investment in local communities) in investment decision-making, with an aim of leading to increased investments in longer-term and sustainable activities- this process is generally referred to as ‘sustainable finance’.

In order to integrate sustainable finance into its law and policy making, the EU Commission established a High Level Expert Group on Sustainable Finance in 2016 and based on their recommendations adopted the Action Plan: Financing Sustainable Growth in March 2018.

The Action Plan sets out an ambitious plan to transform the EU economy into a greener, more resilient and circular system that will reduce its environmental footprint and address existing inequalities. This entails a holistic transformation of the relationship of the economic agents i.e. public and private institutions, small and large businesses and consumers with the environment.

The primary aim is to orientate capital flows to a more sustainable economy.  To this end, the EU Commission first proposes to clarify what is meant by ‘sustainable’ finance via the creation of EU taxonomy of sustainable activities; than building on the taxonomy, to develop standards and labels for sustainable financial product. Businesses are encouraged to design their business models and to develop strategies and technologies that support the long term effects of their investment. Investment fund managers will be obliged to take sustainability considerations into account when acting in the best interest of their clients, and to inform the end investors about the impact of sustainability considerations on their decision and the investors exposure to sustainability risk, for example, climate related risks. The EU Commission also considers factoring in sustainability risks into calculating capital adequacy of banks and insurance companies. The final really interesting addition is a ‘sustainability benchmark’ that will properly measure the performance of sustainable investments. While benchmarks play a central role in the formation of prices of financial instruments (see our report here), the current benchmarks are not designed to reflect on sustainability considerations.

Following the Action Plan in May 2018 the EU Commission adopted a package of measures implementing several key actions laid down in the Action Plan: 1) To create a unified system of classification of sustainable activities it adopted the Proposal for a regulation; 2) To introduce disclosure obligations of investment fund managers it proposed a Regulation amending Directive 2016/2341; 3) Finally, to create a new category of low carbon and positive carbon impact benchmarks it proposed a Regulation amending the Benchmark Regulation.

Naturally, most of the measures set out in the Action Plan are designed to be addressed by private and public businesses. However, the EU Commission has also seen consumers as part of the picture. So what are the role consumers in channelling financial assets towards a sustainable growth?

Well, just as businesses, consumers can also consider the sustainability of their investment decisions. To this end, the above mentioned taxonomy of sustainable activities and labeling of financial products as sustainable could help consumers in their decision making. These are however not specially designed consumer information tools. It seems that the EU Commission did not envisaged independent decision making by consumers. The Action Plan only foresees the regulation of financial advice for investment and insurance products. The Commission (perhaps rightly) assumes that we will not be able to make smart investment decisions on sustainability considerations without financial advice. Do you agree with this approach? Are we incapable to make independent decisions on complex matters such as the sustainability of investment?

Given that financial advice is seen as having a central role in the EU Commissions regulatory approach, we may wonder whether sufficient safeguards are taken into account against mis-selling of sustainable financial products (see our report here). Prior to providing financial advice, the advisers are obliged to assess the consumers risk appetite and investment objectives, including their alignment with sustainability (i.e. environmental, social and business governance factors). However, without proper safeguards consumers may be offered more risky or more expensive sustainable products to invest than they would expect. The EU Commission must make sure that appropriate safeguards are in place, that only those consumers willing to pay more for a moral satisfaction of investing into sustainable projects  are being offered such products, and that these products conform to the individual consumers risk appetite. This is a factor that should be taken into account in formulating the amended rules for MiFiD 2 and Insurance Distribution Directive (IDD) (on which the EU Commission is currently working on).

The other aspect that could be taken into in formulating the rules and policy approach is account is whether consumers need sustainable products, whether there is demand for them. European states are likely to be divided on this aspect. In some Member States consumers may be willing to investment in more risky or more expensive products to support the causes they believe in, whereas in other Member States consumers will only care about the price of the product and the security of their investment. Probably the higher the living standard is the more consumers are inclined to pay attention at sustainability goals. Should the EU Commission direct its activities towards Member States where consumers are more receptive to sustainable finance, or is the phrase ‘think global, act local’ equally applicable here?

Finally, it strikes me that the current approach is somewhat limited to certain investment products, to those provided by investment firms (regulated under MiFID2) and insurance distributors (regulated under the IDD). Any wider effort of engaging (or at least attempting to) on sustainability goals is not attempted.  We are not for example expected to choose our bank based on their ethical policy or the pension fund that we pay into. Should the EU Commission have a more systematic approach, make a wider appeal to sustainable finance that goes be beyond amending the MiFID 2 and the IDD?

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