The EU High Level Expert Group (HLEG) on sustainable finance has a clear goal and a unique opportunity; to set out concrete steps to create a financial system that supports sustainable investments – a priority action of the Capital Markets Union (CMU) Action Plan. This is an opportunity for Europe to lead in orientating its investors, companies and financial institutions, to deliver and benefit from the industrial transition to a sustainable and low carbon economy that is now underway. In the current UK negotiations with Europe this should also be a priority for both parties given the global expertise and thought leadership on sustainable finance that is currently located and headquartered in London.
When I joined FTSE 15 years ago integrating sustainability into investment strategies was a minority sport. Over this period the change has been dramatic. For many years there was gradual increased focus from institutional investors, but over the last two years the pace of change has accelerated to the point where most large institutional investors now aim to integrate sustainability into active and passive strategies as part of all new mandates. The changes on the passive side have been particularly intense over the last year: the majority of new institutional mandates by AUM are passive. The majority of these are smart beta index funds, and the majority of these are now incorporating climate and/or other sustainability parameters into the index design.
This is very different to the previous dominant position that ESG in passive was only about voting and engagement – it’s now all about index design too. For new mandates, it is no longer a minority sport, but the market norm.
At the same time amongst issuers there are very different responses to these change. On one hand there is massive corporate change taking place, with a large proportion of listed companies now having a presence in industries that enable the green economy – we have identified around 3000 companies who now have ‘green revenues’ – i.e. whose products and services have a clear environmental utility across diverse sub-sectors including advanced battery technology, water desalination and waste treatment. On the other hand, most companies are blissfully unaware of the changes taking place among their investors. Many companies reference the fact that few questions refer to sustainability in their analyst meetings. However, the analysts represent one part of the investment chain and many of the world’s largest pension funds are simply changing their core mandates and investments; with investee companies completely unaware.
Without fanfare, large volumes of capital are being shifted into sustainable strategies that incorporate ESG considerations. Last November, for instance, HSBC announced that its corporate pension scheme had switched its default equity fund to a smart beta strategy with three climate change ‘tilts’, underweighting companies with high relative carbon emissions and fossil fuel assets, and with higher exposure towards those with revenues from green industries. Both the risk premia factors and the climate tilts have led to the fund’s historical out-performance against its benchmark.