Double Materiality Should Be The Ultimate Goal | Victor van Hoorn | Executive Director of Eurosif

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INTERVIEW with Victor van Hoorn, the Executive Director of Eurosif, the European Sustainable Investment Forum. For further expert opinions please use the question-level hyperlink.

| Do you expect the pandemic to have a tailwind or rather a headwind effect on the low-carbon transition pace, taking into account the concerns expressed by some market participants in regard to possible funding cuts and the risk of unsustainable recovery measures?

The pandemic has certainly stirred up the debate about the need for the transition to a low-carbon economy to continue. It is a vital discussion we must have.

If we look back at recent history, the 2008-2009 financial crisis had deep impacts on the transition to a low-carbon economy: the economic contraction delayed the transition and bailouts overwhelmingly supported companies and industries reliant on the fossil fuel economy. Academic research subsequently showed that bailout funds tended to have a better and more structural impact in terms of jobs created when they supported new sustainable economic activities. So recent history teaches us that public support focussed on sustainable investments is economically beneficial.

Shifting to the future now, we know the gigantic investment gap we have to meet the 2030 UN SDGs and the 2050 climate objective of carbon neutrality. Many of those investments will be needed to re-engineer entire parts of our economy such as our energy and transportation system, agriculture and our real estate stock. For many of these, it will rely on new and often untested technologies or fund relatively risky infrastructure. For private finance to flow, the risk adjusted return needs to be adequate. And sometimes public funding as a risk-sharing or risk-absorbing mechanism is key to make projects more investable through techniques like blended finance.

Finally, for some investments in large scale infrastructure such as our energy systems, the lock-in period of capital can be for 20 years or more. Which means the capital for these investments will be locked-in beyond 2030, the next set of EU emission objectives. We therefore need to ensure that capital is locked in projects bringing us closer to our net-zero objectives and not further away from them.

 

| Many jurisdictions currently work on ESG-related standards aiming at leadership in the field. What impact do you expect from the competing standards, and what will it mean for asset owners in terms of ESG investing efficiency?  

We have seen a tremendous level of activity by jurisdictions and standard setters indeed in the area of ESG. I do believe we need to be clear about the nature of these standards and what they are trying to address. For example,  regulatory/legal requirements introduced by a jurisdiction will always take precedence over industry-led standards as the former are mandatory and the latter voluntary. And we need to be clear which part of the investment value chain a standard applies to: is it an ESG standard aimed at investment funds, standards aimed at asset-owners or standards on ESG reporting for companies?

The EU is probably the leader in this area with its Sustainable Finance Disclosure Regulation (SFDR) which will legally mandate disclosure for a large range of investment funds, from mutual funds to alternatives, private equity and real estate funds. In parallel, the EU will expand its reporting framework of companies, the EU Non-Financial Reporting Directive (NFRD), in 2021. In parallel, the EU is continuing to develop the scope and depth of its Taxonomy, a system allowing to identify economic activities that are deemed sustainable and aligned with long-term climate mitigation objectives. While these legislation may partially build on existing work by (private) standard setters, the impact is likely to be far greater on the market as these are all mandatory legislation.

 

Taking into account the current ESG standard-related developments, how do you see the future of ESG reporting, and why do global standards matter to investors, above all as part of a resilient recovery?

I think the COVID pandemic and the associated economic shock has strengthened the focus on sustainability and ESG issues. First, from the perspective of good risk management practice in seeking to identify and plan for all risks that can be labelled ESG. Second, from the fact that we need to urgently start addressing in a credible way the long-term sustainability challenges such as climate change, biodiversity loss and water use.

However to achieve successfully both of these goals, investors need much better quality data from companies. And there you see a mixture between public standards (TCFD, EU NFRD) and private standards (SASB, GRI, CDSB, CDP, IIRC), creating a certain reporting burden on companies, while multiplying overlapping standards. And here, the faultline that is emerging globally centers on the question of materiality. Are we seeking reporting and data based on a double materiality (impact on the company and impact of the company on ESG factors) or on financial materiality to the company?

At Eurosif, we believe that double materiality, as promoted by the European Union, should be the ultimate goal. Many of the sustainability challenges I just mentioned are down to negative externalities not having been priced accurately for a long time (i.e. realistic carbon price). If we limit ourselves to financial materiality, we will not be able to appreciate the true extent of the issues until it might be too late. Double materiality would allow us to understand much more robustly the impact of companies on their environment and hence assess some of these externalities, regardless of whether they are priced correctly or not.

 

| The latest Snowball survey found that managers’ behaviours did not always match their impact intent and the impact risk management category highlighted gaps in managers’ management and mitigation of impact risks. How can professional investors spot and tackle inefficiencies, including greenwashing? 

This is going to be the main challenge for the ESG industry in the next decade. We have seen in the last couple of years a spectacular growth of the assets under management in ESG funds which seems to confirm that investors are increasingly seeking to manage ESG risks and their impact on investment returns. The next frontier will be about investors and asset managers demonstrating real world impact of their investment decisions and their engagement with companies they invest in.

In Europe, the SU Sustainable Finance Disclosure Regulation (SFDR) will help. It is based on the double materiality principle, with asset managers being required to report on the principal adverse impacts of their investments on sustainability indicators. While it may not be perfect from day one, we will see over the next couple of years continuous qualitative improvement. And a major impact on greenwashing will be the reporting that ESG funds will have to do as of 2022 on the alignment of their investment portfolio to the EU Taxonomy. This will allow investors to compare different investment products regarding the seriousness of their sustainability ambitions.

 

| How does Eurosif support the investment industry in meeting the upcoming EU Sustainable Finance-related requirements and keeping up with the developments?

The EU SFDR will be a real game changer for the European market for investment funds. It will set the framework for transparency and comparability of ESG investment products. As mentioned though, the SFDR will be a fundamental driver of change over the next few years. At Eurosif, we are both seeking to help our members understand and adapt to the SFDR, while simultaneously speaking to policymakers to ensure that the SFDR and its technical rules deliver on the intended outcome.

 

| brief bio

Victor van Hoorn is the Executive Director of Eurosif, the European Sustainable Investment Forum, the leading pan European Sustainable and Responsible Investment association advocating for a more sustainable financial system. It works as a partnership of European national Sustainable Investment Forums (SIFs). SIF members include institutional investors, asset managers, index providers and ESG research and analysis firms totalling over €8 trillion of assets under management, as well as other stakeholders such as NGOs, trade unions, think-tanks and philanthropic foundations. Eurosif is also a founding member of the Global Sustainable Investment Alliance, the alliance of the largest SIFs around the world.

Prior to Eurosif, Victor was Head of Financial Services at Hume Brophy, a leading EU public affairs consultancy, advising asset managers and asset owners on their engagement with EU policymakers. In that role he closely followed the EU sustainable finance since its inception.

Victor is and attorney-at-law admitted to the New York and Amsterdam bar. He holds the French and Dutch citizenship.

 

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Eurosif is the leading European association for the promotion and advancement of sustainable and responsible investments making a measurable contribution to long term EU and international sustainability goals.