European Commission drafts benchmark to establish common ESG criteria

What’s the latest? The European Commission (EC) drafted a proposal for its much-anticipated sustainable investing taxonomy right at the close of 2021.

The taxonomy creates a common set of criteria to determine which economic activities are sustainable, giving investment firms a metric to screen potential investments.

• The proposal met with outrage from environmental organizations after the EC said it would label natural gas and nuclear energy as green due to their transitional capabilities on the road to decarbonization and meeting emissions targets.
• Other international organizations are also drafting taxonomies to address the lack of common criteria: The Green Digital Finance Alliance (GDFA) and the Swiss Green Fintech Network released a draft taxonomy to help investors, policymakers, and technology providers consistently assess fintechs’ environmental impact.

Why does this matter? Environmental, social, and governance (ESG) investing has taken the asset management industry by storm amid rocketing investor interest—but the space has been plagued by accusations of greenwashing.

• Global inflows into ESG funds exceeded $178 billion for Q1 2020, surging roughly 27% year over year (YoY), according to Morningstar research. Yet each of the 20 largest ESG-labeled funds holds an average of 17 investments in fossil fuel producers—including oil giants like ExxonMobil, per research from The Economist.
• The absence of a common global benchmark that sets out which companies should qualify for ESG-labeled funds is a leading cause of greenwashing.
• Investment firms rely on third-party ratings agencies that use different standards to score companies—which leads to inconsistencies across portfolios.
• Greenwashing threatens to derail this investment strategy: A lack of investor faith in these funds might lead them to divert capital away from sustainable projects.

The role of fintech: Common standards will help to mitigate inconsistencies in company scoring and reporting, but data scarcity remains a thorn in ESG’s side. Fintechs can help with this.

• Almost half of global investors say they are inhibited by a lack of ESG data, per 2021 research from Capital Group.
• And 41% of global firms say finding accurate data is a top challenge, per a June 2021 Capgemini survey.
• So little reliable, quality data exists because investors are stuck with infrequent, nonfinancial company disclosures.
• Asset managers need more data, and they’ll need to mine alternative sources to compensate for the current scarcity.
• Fintechs that offer AI-powered analytics will help asset managers create new insights from sources like news outlets or social media—generating more abundant ESG data. ESG-specialist fintech novisto, for example, offers mining solutions that automate data collection.