How the world is warming to sustainable investing

The EU is considered by many to be the leader in sustainability regulation. This is true in the sense that the EU has been the first to set the foundations for a sustainable finance framework and has a head start in developing the corresponding regulation. But other markets, particularly Asia, are close at its heels and some use the EU’s framework as inspiration.

In this study, we travel around the world (alas only digitally and in fewer than 80 days) to highlight key developments in sustainability policy and regulation. We compare the evolution in regulation to that of the sustainable investment funds market and to what clients have been saying about their attitudes.

Sustainable finance in a nutshell

Different regions take different approaches, with some emphasising regulation and some leaving it to the market to grow more organically.

For example, sustainability policy may start with a government setting a goal for reducing carbon emissions. An action plan soon follows, outlining what needs to change in the real economy to achieve this goal, such as developing new technologies, or greener transport and infrastructure. This is then followed by another plan detailing how the financial sector can help fund the transition.

This brings us to what policymakers call “sustainable finance”. In a nutshell, it is a framework for the financial services sector where climate change and environmental risks are considered in everyday business, operations, products and services. The ultimate intention is for this to become business-as-usual, so that private funding flows consistently towards projects and activities that support the transition to a greener economy.

This definition is narrower than the way we, at Schroders, think of sustainability. For us, sustainability is the outcome that is achieved by tying environmental, social and governance risks to investment and capital allocation decisions. By doing so, the investment industry’s fiduciary goals can become aligned to the wider policy agenda.

More than a fad: the proliferation of sustainability policies beyond the EU

Policymakers have been very prolific in recent years. More than 120 new or revised policy instruments with a sustainability focus were established in 2020 – the highest number ever recorded and over 30% more than in 2019, according to the Principles for Responsible Investment. The sharpest increase has been seen in Europe but there has also been significant activity in Asia.

Our research (found here) looks into the future and explores how much more is yet to come, with significant developments across Asian markets but also, increasingly, the US. As governments unveil roadmaps and action plans to transition their economies, one thing becomes abundantly clear: sustainability regulation is more than a (European) fad.

The future of sustainable investment

The question then is: how interventionist should this regulation be? The acceleration in demand for sustainability-focused investment funds in the last couple of years shows that there is appetite for such investment already. Is it perhaps better to allow the sustainable investment market to grow more organically?

Given how strong the imperative to tackle climate change is and how tangible its cost has become, the recipe for success lies in confluence rather than collision, with regulation facilitating organic growth. Many ingredients are part of this recipe:

• Regulation that is carefully drafted, meaningfully implemented and not rushed despite the urgency
• Global alignment to avoid duplicative and overlapping requirements
• Government-led industrial policy to complement and support sustainable investing
• Long-term planning and consistent policies and regulations across successive administrations

Andy Howard, Global Head of Sustainable Investment, says:

"Sustainable investing has grown massively in recent years and attention from regulators has been inevitable.

This has not come as a surprise to us. The message from our clients, through our global and institutional investor studies, has been clear and consistent. Clients need more transparency and better understanding of their sustainable investment options. They need clarity into the goals and strategies fund managers employ and ways to track their performance. Increasingly, many also want to know the impacts their investments deliver.

We have been listening. We have been preparing for many years and have invested heavily in developing our own proprietary tools, such as SustainEx, to measure the sustainability of our investments and quantify their environmental and social impact. That preparation has created the platform that allows us now to comply with new waves of sustainability regulations globally.

We expect regional differences. Governments worldwide try to tackle similar challenges. Regulators follow the same principles and direction: sustainability needs to shift from something that we talk about to something that we demonstrate. But governments take different approaches to implementation and there will be differences in regulation across regions. Therefore, asset managers cannot afford to approach this as a compliance exercise. We need to have a very clear idea and commitment of why and how we approach sustainable investment and then apply it to our funds.

That is why we, at Schroders, think it is important to use a long-term lens and look not just at the immediate requirements, such as the EU’s Sustainable Finance Disclosures Regulation, but also what happens beyond that.

We will engage with policymakers and make our views and, even, concerns heard where we think it is helpful. Sometimes, we may disagree when regulation tries to prescribe the answer rather than provide a framework that facilitates innovation and choice for our clients. But we will never disagree with the effort that goes into turning “sustainable investment” to simply “investment”.

The fact is that, despite its recent growth, sustainable investing is still in its teenage years. The challenges that policymakers and regulators are trying to solve need to be solved. We, as an industry, need to move from rhetoric to action to demonstrating the benefits of investing sustainabily to our clients. This is what sustainability regulation is getting at. As the saying goes: it is only when the tide goes out that you learn who has been swimming naked. We are reaching a watershed moment worldwide where we find out who didn’t pack their swimsuits. Not a pretty thought."

Please find the full report below.