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Rigorous rules to prevent climate change from causing catastrophic economic damage are set to be imposed on asset managers, pension funds and insurance companies in Europe.
The proposals by the European Commission will impose extra costs on asset managers.
Huge new investment, estimated at €180bn a year until 2030, will be required for Europe to meet the ambitious goals to limit global warming agreed at a landmark conference in Paris in 2015.
The commission is determined to make it easier for savers to buy trustworthy green financial products to help meet the Paris targets. It has suggested that funds could have new green labels, similar to those rating the energy efficiency of domestic appliances such as fridges.
Investment managers will also have to consider environmental risks as a part of their duty to act in the best interest of clients and to disclose how future returns may be affected by climate change.
Valdis Dombrovskis, the EC vice-president who oversees financial services and former prime minister of Latvia, warned last month that “time was running out” to respond to the threat of climate change.
“The Titanic could not turn to avoid the iceberg at the last minute. We will soon be in a very similar situation,” said Mr Dombrovskis.
The EC also plans to establish a sector classification system to determine which economic activities are good for the environment.
It is concerned that “ greenwashing”, the classification of unsuitable products as environmentally sustainable, has been facilitated by differences in current rules.
This initiative is intended as the foundation of a European single market for sustainable investment.
New low-carbon and positive carbon impact indices may be developed as sustainable investment benchmarks and retail investors asked about environmental preferences when they are assessed by financial professionals.
Christian Thimann, a senior adviser at French insurer Axa, has acted as one of the driving forces behind the policies in his role as chairman of the EU’s expert group on sustainable finance.
Environmental risks, says Mr Thimann, are widely mispriced across Europe’s energy, transport and food production sectors. He argues that asset managers are “uniquely placed” to help capital flow towards more sustainable investments.
“Embedding sustainability into stewardship codes and asset management agreements, requiring fund managers to disclose how they integrate environmental, social and governance factors into their strategies and how they vote on ESG issues, are all part of the measures that could be pursued,” says Mr Thimann.
Policymakers face a race against time as the aim is for the proposals to become law before the elections to the European Parliament next May.
Andrew Howard, head of sustainable research at Schroders, the UK-listed asset manager, says it will be vital to stop new disclosure requirements from becoming tickbox exercises rather than leading to meaningful improvements in transparency.
“There is a real need to close down opportunities for greenwashing and marketing being deployed in place of tangible action,” says Mr Howard.
Narrow definitions of suitable green investments under the EC’s proposed taxonomy raise the risk that policymakers miss the opportunity to influence the wider financial system, according to Schroders. “The full spectrum of investment activities needs to change given the scale of the [environmental] challenge,” says Mr Howard.
Wim van Hyfte, global head of responsible investments at Candriam, the €112bn European asset manager, said there was a “real risk of disappointment” due to the narrow focus of the proposals.
“A sustainable economic system needs to be organised differently, using the legislative and tax systems, subsidies and regulations to align economic activity with sustainable development,” said Mr van Hyfte.
Ian Simm, chief executive of Impax Asset Management, an £11bn sustainable investment specialist, says that encouraging investors to focus sharply on climate change should lead to improvements in risk adjusted returns over time.
He believes that policymakers can do more to stimulate demand for renewable energy, green real estate and electric vehicles.
“A lot more could be done through public-private partnerships to attract more capital to sustainable investment projects,” says Mr Simm.
A study published this month in the journal Nature Climate Change warned that between $1tn and $4tn could be wiped off global wealth due to “stranded assets” — fossil fuel reserves that will not be burnt because of improvements in energy efficiency.
“Divestment from fossil fuels is both prudent and necessary. Investment and pension funds need to evaluate how much of their money is in fossil fuel assets and reassess those risks,” says Jean-François Mercure, the lead author of the study, who is employed by Radboud and Cambridge universities.
Caroline Escott, a senior policy officer at the Pensions and Lifetime Savings Association, which represents the interests of 1,300 UK retirement funds, says that it is imperative for that pension fiduciaries consider the effect that climate change could have on their investment portfolios.
“Pension funds should consider voting against directors that are not doing enough to limit the risk of climate change on their business models,” says Ms Escott.