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In search of the real green economy

How can sustainability-focused investors identify genuinely transformative businesses? FTSE Russell’s green economy data model aims to make the job easier by bringing precision to the process.

Is nuclear energy a “green investment”? Do fossil fuel businesses employing carbon capture and storage technologies have a place in the policies of investors focused on sustainability? These are the sort of questions that concern asset managers and other institutions pursuing sustainable investment strategies. Although investors are increasingly focused on environmental, social and governance (ESG) issues, there is precious little agreement on fundamental definitions or about standardisation of approaches.

Regulators worldwide are well aware of this issue. For example, the EU is working hard on a “taxonomy” to establish what can be considered green and what can’t. The framework focuses on a list of economic activities, setting performance criteria to assess their contribution to environmental objectives ranging from climate change mitigation to the transition to a circular economy.

The EU’s efforts are mirrored in other jurisdictions. China, Japan, Singapore and Canada are all now working on their own taxonomies, while the UK set up the Green Technical Advisory Group earlier in 2021 to look at whether the EU taxonomy’s metrics are appropriate for the UK.

However, Lee Clements, Head of Sustainable Investment Solutions at the London Stock Exchange Group (LSEG), says that while all of this will go some way to resolving fundamental questions about sustainable investment, taxonomies simply provide a foundation. “With the development of multiple new green taxonomies at the national level broad, it is widely accepted that granular data sets are going to be key in their implementation,” he says. “One of the main challenges is taking the step from defining taxonomies to the generation of company level data, where the level of disclosure is low.”

Asset managers focused on sustainability are familiar with the problem. “While sustainable disclosure has improved considerably across the market capitalisation spectrum, we encounter greater disclosure challenges with smaller companies that typically don’t have the same level of resources as their larger cap peers,” says David Osfield, who manages the EdenTree Responsible and Sustainable Global Equity Fund. “Our fund aims to find sustainable companies before they are well recognised by the market.”

Seizing the opportunity

The need to confront such challenges underpins the FTSE Russell Green Revenues 2.0 data model. FTSE Russell’s model provides investors with data that covers more than 16,000 companies and has identified about 3,000 global listed companies with exposure to the green economy. The model looks at the extent to which companies offer green products or services, determining environmental impact based on seven objectives, ranging from energy generation to waste and pollution control.

In addition, the model divides supposedly green businesses into three tiers based on the level of environmental benefits their activities generate. Tier 1 companies offer clear and significant benefits; tier 2 companies can be considered as net positive in terms of the benefits they create; and tier 3 companies offer more limited benefits.

The model has a range of potential use cases. For actively managed sustainable investment funds, it supports managers’ work as they attempt to assess whether particular holdings are appropriate for their mandates. It can also be used to develop passively managed index-linked funds. More broadly, the model provides a continuing read-out on the state of the green economy and supports any asset manager weighing up sustainability issues when managing portfolios.

The size of the market captured by the FTSE Russell model underlines the growing opportunities in ESG investment. The businesses collectively have market capitalisation of $4tn, equivalent to more than 5 per cent of the total capitalisation of global equity markets — these green economy companies have now overtaken the oil and gas sector by size.

“The green economy has grown faster than the overall equity market,” adds Clements. “[But] this growth will need to accelerate if the world is to meet the investment levels outlined to achieve the objective of keeping global warming within two degrees.”

It’s a warning that resonates with Neil Goddin, co-manager of the Positive Future Fund at asset management firm Artemis, who believes sustainability investors have a responsibility to identify genuinely transformative companies, rather than traditional businesses that are simply improving their behaviours and activities. “It is not going to be enough to do things incrementally better,” he warns. “Right now, one in five people dying around the world each day die from causes connected to fossil fuels. Why wouldn’t we want to solve that?”

Good-quality data is key in identifying the most transformative companies and in holding managers to account, Goddin says. “We can all point to sustainable funds that really aren’t very different to conventional global equity funds,” he adds.

For those who hope the growing ESG investment sector will really drive change, this is a vital debate. “As focus increases on the green economy, national taxonomies are developed, climate targets and technologies evolve and corporate disclosure improves, one of the challenges will remain consistent data sets,” concludes LSEG’s Clements.

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