Market view and Insights
In May 2018, the European Commission published the Sustainable Finance Action Plan. So what’s next? And has it made the financial industry and the economy more sustainable?
The European Union (EU) is one of the world's most important economies. Four years ago, it made a commitment to promote more sustainable finance. As a result, a number of initiatives and binding measures have emerged to promote sustainable investing and help pave the way to a low-carbon economy.
For example, these days, millions of investors are receiving a letter from their financial institution informing them how sustainably their money is invested. This is just one of the tangible impacts of the Investor Action Plan in Europe.
The letter comes as a result of the revision of the EU's MiFID II financial markets directive. This unwieldy term refers to binding regulation of the European Commission, according to which, among other things, European stocks and funds must provide information about their sustainability. The second edition of the EU directive sets standards, particularly with regard to sustainability.
All this is happening at a time when the topic of sustainable finance has moved from a niche to the focus of investors. For example, the share of sustainable investments has increased exponentially over the past three years. Institutional investors in particular have been at the forefront of this trend.
However, this success story has been marred by various scandals relating to greenwashing. So where does the financial industry stand on the issue of sustainable finance? We spoke to Chris Greenwald, Head of Sustainable Investing, LGT Private Banking, about this.
Question: Why do institutional investors include sustainable investments in their portfolios so much more often than private investors?
Institutional investors have faced increased pressure from their stakeholders to invest sustainably. Their response to this pressure has driven growth in their allocations to sustainable investing (SI).
Also, many institutions have moved their assets from active to passive strategies over the past two decades. As a result, asset owners are less exposed to stock-specific risks and more exposed to long-term systematic risks, because index returns will ultimately be driven by the overall long-term health of the economy.
If you are interested not only in the financial dimension, but also in the environmental and social impact of your investments, then you should be familiar with these three letters.
This has led many asset owners to focus on long-term issues such as climate change or the rise of social inequality. These have long-term impacts on the economy, a fact that has led many institutional asset owners to demand more action on sustainability from their asset managers.
Question: But this trend toward more sustainable finance is at odds with what is currently still often happening in private banking, is it not?
Looking at the private banking industry as a whole, surveys show a significant discrepancy between private clients' interest in sustainable investing and what they are actually invested in. But relationship managers at a number of banks have historically not explained sustainable investment options to their clients.
This will change with the MiFID II regulations, given that every relationship manager in the EU will be required to have conversations with their clients about their interest in sustainable investing. They will also be required to explain to interested clients the various opportunities that they have for investing sustainably.
Question: What do you expect from the EU's additional information requirements?
We anticipate that this will lead to continued growth in sustainable investment assets, expanding the movement that began in the institutional space to private banking and thereby mainstreaming sustainable investments for private clients.
Question: LGT has been involved in sustainable investments for years. What have you done to increase your clients' interest in this topic during that time?
LGT has developed its own sustainability rating through the ESG Cockpit. The rating brings together various data sources into a score that is transparent and based on the most relevant data points and is organized in a way that focuses on the most material sustainability topics per sector. By building the rating ourselves, we are able to provide a level of transparency that we can explain in detail to interested clients.
In addition to our rating, we also have our own Sustainable Investing mandate that is internally managed by our PM team. This allows us to pick the best securities for the mandate from a sustainability perspective and to explain in depth the sustainability performance of the companies held within the mandate. This high level of transparency and conviction gives clients the confidence in the sustainable investment strategy.
LGT has also developed a sustainable advisory offering that allows clients to choose the sustainability themes that matter most to them and to invest accordingly in companies that match these themes. We believe that this is the most compelling way to offer sustainable investing to private clients, given that they increasingly expect customized solutions that are tailored to their specific interests.
Question: If companies can decide for themselves to be highly committed to sustainability, as exemplified by LGT, why do we need the regulations and plans of the European Union?
Sustainable investing has grown very quickly over the past three years, and there is a need for standardization with regard to what is meant by the term "sustainable investing". Different managers have defined it differently, and this can be confusing for many clients. One of the key goals of the EU’s regulation is to develop standardized definitions of sustainable investing. In addition, the legislation will require companies to report on a standardized set of metrics for what counts as "sustainable" business activities. This level of consistency in company reporting will allow clients to better compare when establishing sustainable investment strategies.
From our point of view, the EU’s regulation is also an opportunity to overcome greenwashing - not so much through the regulation per se, but because it will provide clients with a range of sustainable investment options. Clients will naturally choose the best performing funds with the most compelling approach to sustainability. This natural selection process driven by client choice is probably the most efficient mechanism for overcoming greenwashing and ensuring that capital flows to the best sustainable investment strategies.
Question: Liechtenstein and Switzerland are two of LGT's most important locations. Why are the EU action plan and the resulting activities of the European Union also important for financial companies in these two countries? After all, they are not members of the EU.
In contrast to Switzerland, Liechtenstein is a member of the European Economic Area (EEA), so EU regulations incorporated into the EEA Agreement and/or implemented into national law are binding for our Liechtenstein clients.
And because the topic of sustainable finance is of strategic importance to LGT and its owners, the princely family, LGT also implements the updates to the investor profile for clients in Switzerland. We believe that sustainability adds value to the investment process and represents the best way to invest for the long term. We have therefore rolled out the MiFID II questions to the investor profile beyond what is required by regulation, as this represents an opportunity for us to explain the wide range of compelling sustainable investment options that LGT offers.
Question: Which challenges does the financial industry still need to address in the coming years? And which developments could be interesting for your clients? Can you tell us anything on that front or is it still too early?
One of the key emerging areas in private banking is stewardship. This includes both active engagement and proxy voting. While this topic is quite advanced in the institutional market, it is relatively new within private banking. We believe that it represents a huge opportunity for growth for the private clients segment.
Clients are particularly interested in the difference that sustainable investing makes in the world, and engagement allows clients to understand this impact from their investment strategies. That's why LGT recently announced a partnership with BMO Asset Management for engagement services. This new offering will allow us to demonstrate the tangible progress that can be made on improving companies' environmental and social performance through engagement.
LGT relies on its own ESG rating. On the one hand, this enables us to better analyze how sustainably our clients' assets are invested. On the other hand, LGT's ESG rating can also help to prevent investments in companies that purport to be green but are ultimately just greenwashing.
However, proxy voting remains a challenge for many private banks. Nevertheless, we are committed to enhancing our offering through proxy voting where possible. Private banks will hopefully start to vote more actively in the coming years, which will put additional pressure on companies to act sustainably and to transition their strategies toward a low-carbon future.
But we look at more than just our offerings and services. Our entire company must act sustainably, which is why LGT is also committed to being net zero by 2030. We have set our sights on 2030 rather than 2050 due to the urgency of the challenge posed by climate change. As part of this, LGT will focus on carbon risk reduction over the next eight years, and we have committed to remove CO2 from the atmosphere in order to compensate for any emissions that may be in our portfolios in 2030.
LGT committed to sustainability early on. Long-term and sustainable thinking and actions have always been among the company’s strongest characteristics. LGT has therefore been working to further strengthen its commitment to sustainability both in its operations and in its core businesses, private banking and asset management, for many years now. It is important to LGT that its business activities make a positive contribution to the environment and society. You can learn about how it achieves this here.