The sustainable investing market is witnessing remarkable growth: since 2018, annual cash flows into sustainable funds have increased tenfold. Now, more than ever, investors and asset managers alike seek sustainable products and strategies offering robust financial returns. The field, however, has been haunted by greenwashing claims and a lack of consistency in identifying what, exactly, makes an investment “sustainable”.
Sustainability or “green” taxonomies developed by governments, international bodies and non-governmental organizations (NGOs) can help resolve these challenges and inconsistencies by identifying specific assets, activities or projects that meet defined thresholds and metrics that quantify sustainability. These systems can cover the full spectrum of sustainability topics, from achieving acceptable levels of greenhouse gas emissions to compliance with certain human rights standards. Among other benefits, sustainability taxonomies can:
- assist investors, asset managers and asset owners in identifying sustainable investment opportunities and constructing sustainable portfolios that align with taxonomy criteria;
- drive capital more efficiently toward priority sustainability projects;
- help protect asset managers against claims of greenwashing by providing an independent benchmark for the sustainability performance of investments; and
- guide future public policies and regulations targeting specific economic activities based on taxonomy criteria.
In this series of Blog Posts, we first provide a brief overview of some of the key existing and developing taxonomies around the world. We then set out our analysis of the ways asset managers are already leveraging taxonomies in their businesses based on a review of publicly available responsible investment reports. Finally, we highlight certain challenges that asset managers may encounter as these systems develop and interest in sustainable investing continues to grow.
Continue reading this Part III to understand some of the taxonomy-related challenges that asset managers may encounter. You can find Parts I and II here and here.
The proliferation of taxonomies can benefit asset managers seeking to develop robust sustainable investment solutions, but this new landscape is not without its burdens. Asset managers may encounter the following challenges when applying sustainability taxonomies:
- Taxonomy fragmentation – the risk that what is “green” according to one taxonomy is not “green” according to another – must be monitored and addressed. This is particularly relevant for multinational asset managers seeking to apply national sustainability taxonomies to operations in multiple jurisdictions. As taxonomies proliferate, asset managers must ensure broadly applicable group-level frameworks are appropriately tailored for local regulation and circumstances.
- There is a general lack of robust brown or transition taxonomies, which provide criteria and methodologies to help identify and incentivize companies operating in “brown” sectors like oil and gas to transition to greener practices. Asset managers interested in investing sustainably in these sectors might consider developing their own, internal brown or transition taxonomies.
- Asset owners may expect or require alignment with certain “leading” taxonomies. As national taxonomies develop, it is important to note that expectations and requirements can be informed by regulation or policy in the asset owner’s home jurisdiction – for example, an asset owner headquartered in Europe may require its asset managers to incorporate or report on alignment with the EU Taxonomy, regardless of where an asset manager is headquartered. In this context, asset managers must engage their investors to understand their needs and respond accordingly.
Despite their challenges, taxonomies have the potential to significantly increase investor and other stakeholder confidence in sustainable investing by providing concrete, reliable definitions of sustainability principles, factors and activities. Asset managers that proactively address these challenges and effectively leverage taxonomies in their own businesses can obtain a competitive advantage at a time when the market for sustainable products is rapidly expanding. Most importantly, when asset managers use taxonomies to develop more effective sustainable investing strategies, the end result is often a business that delivers better outcomes for our planet and people.