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Elsewhere on Wednesday,

— Don’t take metrics at face value.

— Shorting renewables company Loop.

— Solar is filthy cheap .

— Tesla plant protests.

— The mystery of the amber room has been solved.

— What even is Softbank?

— Bots now pass for humans on Reddit thanks to GPT-3.

— What’s the latest on settlement failures?

— Creepy light therapies that can control your brain.


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Analysis

EU rules promise to reshape opaque world of sustainable investment

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Anders Bertramsen likes to know what he is eating so when he does his weekly shop he checks food labels for nutrients and provenance before choosing products. But in his professional role selecting sustainable investment funds for wealthy investors, he finds it much harder to make such judgment calls.

“It is a maze out there,” says the head of external fund selection at Nordic bank and wealth manager Nordea. “Getting to the bottom of which funds are truly sustainable requires a lot of time and experience.”

For Mr Bertramsen, the EU’s introduction in March of landmark rules mandating greater transparency for environmental, social and governance funds cannot come soon enough. “We will have a lot more data, which will help weed out the managers who talk themselves up on ESG but don’t do anything.”

The sustainable finance disclosure regulations require fund groups to provide information about the ESG risks in their portfolios for the first time. A central plank of the EU’s green deal, they aim to push more capital towards sustainable activities by injecting discipline into the ESG market.

The rules are not just good news for professional investors such as Mr Bertramsen; they will also help retail savers, from millennials to sustainability-focused older people, who want the tools to cut through the ESG noise.

ESG investing has exploded in recent years as investors’ growing awareness of issues such as climate change pushes them to invest in funds that benefit society in addition to generating returns.

ESG funds in Europe attracted net inflows of €151bn between January and October last year, an almost 78 per cent increase from the same period in 2019, according to Morningstar. Yet the boom has been overshadowed by concerns that some providers have been overstating their sustainability credentials to win business, a trend known as greenwashing.

However, the new EU rules will shake up ESG investing by exposing laggards and forcing the investment industry as a whole to improve its offer.

“It is hard to overstate the impact that the regulations will have,” says Thomas Tayler, senior manager at Aviva Investors’ Sustainable Finance Centre for Excellence. “It is going to change the way people run their businesses by putting sustainability right at the heart of the investment process.”

The ambition of the new regime is evident from its scope: it is not solely targeting sustainable funds. Under the rules, all asset managers will have to consider sustainability risks alongside other financial risks, before disclosing to investors how these are managed or why they are not relevant.

Only a few years ago, this approach — known as ESG integration — was the preserve of a handful of ESG specialists, says Mr Tayler. But he adds that the comply or explain nature of the new rules will jolt more asset managers into action, transforming ESG integration into a baseline requirement for all funds.

Meanwhile, the increased reporting requirements imposed will also raise the bar among sustainability-focused asset managers. Under the new rules, funds that claim they go further on ESG — such as impact funds, which place environmental or social goals on a par with financial profit — will have to back up their virtuous statements with clear evidence of their sustainability efforts.

Valentin Allard, senior consultant at research group Indefi, says the fact that ESG managers will have to disclose the same data will make it easier to sort the wheat from the chaff.

“A lot of masks will fall,” he predicts. “Once everyone is reporting against the same indicators, some people might realise they overstretched how green they really are.”

At the same time, the spotlight that the EU framework will shine on ESG is likely to lead to a surge in sustainable fund launches, as asset managers rush to adapt their products to the new world.

“The market will be changed by the regulations,” says Olivier Carré, a partner at PwC Luxembourg. “Asset managers have to decide how they want to be positioned in this new environment.”

PwC believes ESG funds could increase their share of total European assets from 15 per cent to 57 per cent by 2025 on the back of the EU rules, with the bulk of the growth coming from conversions of non-ESG funds into funds compliant with the new regulations.

The onus on managers to up their game is made more urgent by the fact that their clients — pension funds, insurance companies and financial advisers — will also be obliged to consider sustainability under the rules, leading to even greater demand for ESG funds.

ESG funds are powering into the mainstream

However, teething problems with the regulations and questions over how they link up with other EU legislation will probably hinder growth in the ESG industry.

Brussels recently delayed the date by which asset managers will have to submit the bulk of the disclosures following resistance from the industry.

But even with the delay, compliance will be a struggle due to the sheer volume of data that must be gathered. “If I look at how many people in my company are working on [the ESG regulations], it is almost as big as Mifid II was,” says Gilbert Van Hassel, chief executive of €158bn Dutch asset manager Robeco, referring to the sweeping EU markets rules that came into force in 2018.

A major stumbling block for asset managers is sourcing sustainability data from the companies they invest in. The lack of global standards for corporate ESG disclosures means that the availability and quality of information varies wildly.

Sustainable finance trade body Eurosif estimates that of the 32 ESG data points asset managers are required to report under current proposals, just eight are available today.

The EU is aiming to solve this problem by imposing new obligations on companies as part of its review of the Non-Financial Reporting Directive, which governs sustainability disclosures. But this may not be finalised in time for asset managers’ first detailed ESG reporting deadline in 2022.

Another challenge is the lack of alignment between the reporting requirements and the EU’s taxonomy regulation, the flagship classification system on what counts as green investment, which effectively obliges fund groups to make two separate sets of ESG disclosures.

Mr Tayler says asset managers will learn by doing and will evolve over time to meet policymakers’ high expectations.

However, a bigger long-term question is whether the disclosure regulation will truly be effective in stamping out greenwashing and channelling money to sustainable economic activities.

Victor van Hoorn, Eurosif executive director, says much will depend on whether investors read the disclosures and the extent to which regulators vet them. The financial regulators in Europe’s two largest fund hubs, Luxembourg and Ireland, have indicated they will allow asset managers to self-certify they comply with the rules.

Given that the EU regulation does not impose minimum standards for ESG funds, “it could actually make it more difficult to spot the asset managers that are good at ESG”, he warns.

This is a view shared by the French financial regulator, the AMF, which recently started to require local funds to comply with minimum thresholds in order to market themselves as ESG.

The watchdog wants to see similar rules introduced at EU level to safeguard investors and protect the credibility of ESG investing. It is also calling for EU-wide oversight for ESG data and rating providers, which have come under fire over their inconsistent methodologies. “We feel that this issue, which is directly linked to greenwashing, is not yet addressed by the [forthcoming] EU regulations,” says Robert Ophèle, chairman of the AMF.

Nathan Fabian, chief responsible investment officer at Principles for Responsible Investment, says that with the new ESG rules, investors can judge for themselves how sustainable a fund is and act accordingly. However, he adds that “if money doesn’t start to be redirected, governments won’t have much choice” but to introduce minimum standards.

Given the net zero emission targets that many countries have set themselves, they are likely to impose more binding rules in future to ensure financial products are aligned with sustainability goals, he says.

The EU’s ESG road map

March 10 2021

Entry into force of Sustainable Finance Disclosures Regulation

Asset managers required to define entity-level ESG policies and make ESG disclosures in pre-contractual documents

Q1 2021

European Commission expected to kick off review of the Non-Financial Reporting Directive governing corporate ESG disclosures

January 1 2022

First deadline for asset managers to submit annual product-level ESG disclosures in line with SFDR

Asset managers required to report on climate change mitigation and adaptation in line with the EU taxonomy

Q1/Q2 2022

Expected application of rules obliging financial advisers to take into account clients’ sustainability preferences



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Analysis

Residential rents plummet in major UK cities

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Rents are falling fast in major cities across the UK as a result of coronavirus, which has caused demand for properties from overseas workers, students, tourists and corporate travellers to plummet. 

The falls are most pronounced in London, the city in the UK most exposed to the demand shock unleashed by the pandemic. But rents in Manchester, Birmingham, Edinburgh, Leeds and Reading have also tumbled in recent months, and are unlikely to rebound quickly, according to data from property portal Zoopla.

In the 12 months to October, average rents in London fell 6.9 per cent; in Birmingham they slipped 3.2 per cent; in Reading 2.2 per cent and in Edinburgh 1.7 per cent. All cities in the analysis fell below their surrounding region, reflecting weak demand for accommodation closer to town centres.

Charts showing that residential rent growth in cities is less than their regional average

Rents had continued to grow in Leeds and Manchester through much of the pandemic, but both dipped into negative territory in the year to October.

That marks a dramatic reversal: in the year to March, when the first national coronavirus lockdown was introduced, rents in Leeds increased by more than 4 per cent; in Edinburgh average rents were up 2.5 per cent.

The sharp falls come against a background of rapid and profound change in the most affected cities, with the pandemic shifting demographics, working patterns and the financial status of many residents. With foreign travel banned or limited for much of the past 12 months, foreign students, workers and tourists have been unable to come to the UK. 

The increased prevalence of homeworking has frayed bonds to the office, and allowed renters to relocate further afield. Rather than living in expensive city centres, in order to save on travel costs many have chosen to move to the fringes of cities or beyond, even temporarily.

In each of the cities covered in this analysis, the return to work has been halting and extremely limited, according to Google mobility data. Areas such as Edinburgh and Reading, which have had some of the steepest falls in rent, have also been among those with the lowest workplace activity.

Chart showing declining workplace mobility for UK cities

A further factor is job loss, which has triggered a mass exodus of overseas workers, who have an outsized role in the coronavirus-ravaged hospitality industry. According to a statistical analysis by the government-funded Economic Statistics Centre of Excellence (ESCoE), 1.3m people born abroad left the UK between the third quarter of 2019 and the same period in 2020.

According to the ESCoE, more than half of those departees were from London, the city hit hardest by rent falls. At the start of 2020, just one of London’s 33 boroughs — the City — was facing an annual fall in rents. Four months later, that had jumped to seven, as the first national lockdown took hold. In Zoopla’s latest figures to October, rents were falling in 25 boroughs — or three-quarters of the total.

The boroughs in which rents did not drop are all at London’s periphery, while the sharpest falls came in inner London boroughs which contain tourist hotspots and office hubs. The boroughs of Islington, Westminster and Kensington & Chelsea, which include some of the most expensive postcodes in the country, have experienced falls of around 10 per cent in the year to October. 

Animated gif showing residential rental growth in London boroughs

Pricier areas have fared worst. For each extra £100 spent in relation to a home’s location, the annual fall was approximately one percentage point greater.

The cooling of rental markets within the UK’s major cities contrasts with what is happening outside of them. Nationwide, average rents are growing at 2 per cent a year excluding London. Paradoxically, rental growth outside urban centres can also be attributed in part to Coronavirus, said Richard Donnell, research director at property portal Zoopla. 

“In times of economic uncertainty demand for renting increases as people put plans to buy a home on hold and stay put or continue to rent where they live,” he said. A squeeze on mortgage availability, with lenders removing many of their riskier high loan-to-value products in the second half of 2020, has meant some renters are forced to stay put, he added. 

Renters outside the major cities have a relatively limited selection of properties to choose from, with many private landlords having left the market in recent years on the back of increases in stamp duty and reductions in tax relief for buy-to-let landlords in 2016, said Mr Donnell. According to Zoopla, the number of private landlords buying new properties to rent is less than half the level it was in 2015. 

In major cities such as London and Manchester, there has instead been a boost in supply in recent years, as specialist rental developers such as Greystar, Quintain and Get Living look to tap into the UK’s nascent ‘build to rent’ market — in which corporate landlords professionally manage large rental blocks.

And the chilling effect of coronavirus on rental markets in major cities may persist even once the pandemic has passed. A ban on evictions and the continuation of the government’s furlough scheme are ensuring that the 7 per cent of tenants who have fallen into arrears can remain in their properties. But those are temporary measures, and there is likely to be more pain when those lapse, according to Andrew Wishart, property economist at Capital Economics.

Additional reporting by Patrick Mathurin and Chris Campbell



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Analysis

How Joe Biden’s stimulus plan shook up global financial markets

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The “blue wave” hit later than expected, but with enough strength to force a reordering of global financial markets.

Victories in US Senate run-off elections in Georgia held on January 5, which handed the Democratic party control of Congress to add to the presidency, jolted investors into overhauling their portfolios in anticipation of the beefed-up fiscal stimulus promised by US president-elect Joe Biden — who detailed his $1.9tn plan on Thursday.

The effects have been far reaching: technology stocks have struggled, while the prices of commodities used in infrastructure projects, such as copper, and shares in machinery manufacturers such as John Deere and Caterpillar have advanced. Global crude oil prices reached above $55 a barrel for the first time since the pandemic rattled markets. And lower-rated US state and local debt has rallied on the promise of extra federal support.

But perhaps the most important impact is in the government bond markets that form the basis for other asset prices around the world. Analysts now expect a splurge of extra debt issuance, and higher inflation, putting pressure on the Federal Reserve to wind down its bond-buying programme and potentially even increase interest rates earlier than expected. Ten-year and 30-year government bond prices have dropped since the start of the year, pushing yields to around their highest level in almost 10 months.

“A lot of assets have been built on the prospects of extremely low interest rates for the foreseeable future,” said Mike Stritch, chief investment officer at BMO Wealth Management. “In terms of financial risks, we think that is one of the big ones.”

The promise of extra spending — which comes on the heels of a $900bn spending bill passed by Congress last month — was “setting the stage for a rise in inflation”, Morgan Stanley economists said earlier this month.

Line chart of US 10-year break-even rate, % showing Investors brace for higher inflation

The so-called 10-year “break-even” rate, a measure of market expectations for price rises which is derived from the price of inflation-protected government bonds, has climbed above 2 per cent. That is up from less than 0.5 per cent at the depths of the crisis last year.

Meanwhile, the leader board in US stocks has switched. Long-favoured tech stocks including Apple, Microsoft and Salesforce have lagged behind the broad market since the run-offs on January 5. By Friday’s close of trading on Wall Street, tech stocks on the Russell 3000 index were slightly down for the year, trailing a gain of 4 per cent for basic materials groups, an almost 5 per cent rise for financials and an advance of about 14 per cent for energy companies.

The tech sector has outperformed since the financial crisis, against the backdrop of lacklustre global economic activity — a trend that was exacerbated during the pandemic. Rock-bottom interest rates bolstered the appeal of businesses whose valuations were dependent on profits in the distant future, while dragging on sectors such as banks.

Line chart of Daily prices, rebased, % change showing Small-cap stocks have risen with the ‘blue wave’ as tech lags

A rotation away from tech into economically sensitive sectors such as small-caps and unloved “value” stocks, including financials, began to take hold last year as prospects grew for a “blue wave” in US elections. But the Democrats’ initial failure to secure a majority in the Senate in November left many investors positioning instead for gridlock in Washington.

The Georgia run-offs reignited this trade. The results were “the straw that broke the camel’s back”, said Bob Doll, a senior portfolio manager with asset manager Nuveen. “After years when you wanted to brag about how many big growth stocks you owned . . . you’re now at the point where you need to have small, value and international stocks in your portfolio.”

Consumers and businesses are likely to remain reliant on the technology companies that filled gaps during the crisis, but the rollout of coronavirus vaccinations and the extra government spending should lift those sectors hardest hit by the pandemic.

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In anticipation of an economic recovery filtering across the American heartland, investors have ploughed roughly $27bn into small-cap stock funds since the start of November, more than reversing the entirety of outflows the funds had tallied in the first 10 months of the year. Small businesses are expected to flourish as Americans plot a path back to normal life. Emerging market exporters are also predicted to benefit as demand rebounds.

Demand for hedges against rising prices has also been strong, with US funds that buy Treasury inflation-linked securities, or Tips, attracting almost $1.5bn of net inflows in the week ending Wednesday, according to data from EPFR. That marked the 15th consecutive week where more money entered these funds than left them.

Column chart of Weekly flows into US inflation protected Treasury funds ($bn) showing Investors seek out inflation hedges

The question now is just how much fuel the Democrats will add to the world’s biggest economy, at a time where monetary policy remains ultra-loose.

“The global economy and US economy are experiencing early cycle dynamics characterised by rising growth, rising corporate earnings, rising prices,” said Erik Knutzen, Neuberger Berman’s chief investment officer of multi-asset strategy.

“But [that is] still in a very accommodative monetary policy environment and . . . with a fair bit of fiscal stimulus coming through.”



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