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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

Covid paralyses Asia as western economies prepare for blast-off

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Throughout 2020, Asia’s success in controlling Covid-19 made it the champion of the world economy. While Europe and the US were mired in deep recessions, much of Asia escaped with a shallower downturn or even kept growing.

But as western economies gear up for a vaccine-induced rebound which is set to take their output back to its pre-pandemic scale by the end of this year, parts of Asia are still paralysed by coronavirus. As a result, although the region’s output is already above its pre-pandemic level, slower growth is expected in the coming months.

As it launched its new regional outlook last week, the Asian Development Bank said that the region’s economies were diverging and that more Covid-19 waves were a big risk.

“New outbreaks continue, in part due to new variants, and many Asian economies face challenges in procuring and administering vaccines,” said Yasuyuki Sawada, the ADB’s chief economist.

The ADB projected growth of 5.6 per cent across developing Asian economies in 2021, led by growth of 8.1 per cent in China and 11 per cent in India. But the continued threat of coronavirus means risks to that outlook are skewed to the downside.

“Six months ago, or eight months ago, I would have said Asia is going to be ahead of the game because Asia can control Covid,” said Steve Cochrane, chief Apac economist at Moody’s Analytics in Singapore.

But the picture has changed, with India suffering a severe wave of the virus, and cases still high in countries such as Indonesia, the Philippines and Thailand. Thailand is unable to reopen its crucial tourist industry.

More subtly, countries such as Japan are only controlling the virus with restrictions that keep parts of the economy in hibernation. “Some countries need vaccines to control Covid,” said Cochrane. “Others need it so they can open up to international travel and tourism.”

The promise of more than 6 per cent growth in the US this year, as a result of President Joe Biden’s fiscal stimulus, would normally have Asian exporters licking their lips.

Line chart of GDP rebased (2019 = 100) showing Asian economies were less affected by the early stages of the pandemic

The outlook, however, is more subdued than record US growth would usually imply: Americans already bought plenty of goods during the pandemic, while higher US interest rates would mean tighter financial conditions in Asia.

“Adding stimulus at this stage, from the goods perspective, is a real test of whether wants are insatiable,” said Freya Beamish, chief Asia economist at Pantheon Macroeconomics. As the economy opens up, US consumers will probably pay for the services they were denied during lockdown — such as meals out and haircuts — rather than replacing their television again.

There will still be some spillover from the US stimulus, said Beamish, noting that service providers needed equipment, too. “We suspect that people will find new goods to buy and that Asia will benefit from that.” But she added: “We suspect that China will benefit proportionately less from the services recovery than from the manufacturing recovery.”

Whether the extra US demand for goods turns out to be large or small, it is clearly positive. By contrast, higher US interest rates and a stronger dollar would threaten many emerging Asian economies with a repeat of the 2013 “taper tantrum”.

Increased financial integration and foreign currency borrowing mean that the pain of rising US interest rates is quickly felt on the other side of the Pacific.

“A stronger dollar is no longer an unalloyed blessing for Asia,” said Frederic Neumann, co-head of Asia economics at HSBC in Hong Kong. “It helps exports but tightens financial conditions.”

However, inflation is subdued across most of emerging Asia, and the ADB said the risk of a US-induced shock to financial conditions “remains manageable at present”. It said economies such as Sri Lanka and Laos would be vulnerable if such a shock occurred.

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Some Asian economies are well-placed for the next few years, especially Taiwan and South Korea, which are exposed to the semiconductor cycle. “Judging from semiconductor shortages, it doesn’t look like the electronics cycle will break down in the next two or three quarters. That tides them over this rough patch,” said Neumann.

But other Asian economies will find themselves in the less familiar position of relying on domestic demand to grow. One of the biggest question marks is China itself, where first quarter numbers suggest the economy has lost a little momentum.

“Chinese domestic demand still has a way to go,” said Cochrane. “Our forecast right now is for 8 per cent growth in China in 2021, but it depends a lot on policymakers and how quickly they pull back on stimulus and introduce frictions in areas like construction.”



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Has Venezuela’s economy bottomed out?

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After one of the biggest economic meltdowns in Latin American history, there are signs that Venezuela may finally be turning a corner.

According to some economists, the socialist government’s decisions to loosen currency controls, relax import restrictions and encourage informal dollarisation have breathed a modicum of life into an economy that has shrunk by about 75 per cent since 2013.

The change of government in the White House has also raised hopes that a solution might be found to the country’s long-running political stalemate, which might lead to an easing of US sanctions and in turn fuel a further rebound.

Credit Suisse recently predicted the Venezuelan economy would expand by 4 per cent this year, which would be its first year of growth since 2013. The bank acknowledged this was in part due to the resumption of economic activity after last year’s hit from the coronavirus pandemic, but this was “not the whole story”.

“The revival in domestic demand, which we have long been noting, is becoming more apparent in the data,” Alberto Rojas, the bank’s chief economist for Venezuela, wrote in a note to clients.

“The easing of controls and widespread use of foreign currencies in everyday transactions has rekindled economic activity — even if just slightly.”

Rojas forecasts further growth of 3 per cent in 2022. “In our view, the growth this year is not just a dead cat bounce,” he wrote.

In Caracas, people were sceptical that this amounted to any sort of meaningful recovery. According to the IMF, per capita gross domestic product in Venezuela has dropped a staggering 87 per cent over the past decade, from $12,200 a year in 2011 to $1,540 now. For the first time, the average Venezuelan is poorer than the average Haitian.

“When you’ve fallen so low, eventually you’re bound to see some sort of correction,” said Adán Celis, president of Venezuela’s manufacturers’ association Conindustria. “The government has introduced some anarchic measures of economic flexibility and that’s provided us with a little bit of oxygen but the structural problems remain.”

But a handful of other banks and consultancies also expect output to increase. Two Venezuelan consultancies, AGPV and Dinámica Venezuela, predict growth this year of 1.9 per cent and 2.3 per cent respectively.

UK-based Oxford Economics forecasts growth of 0.2 per cent this year followed by a jump of 13.1 per cent next year, although it stresses this recovery needs to be seen in context.

“This follows two years in a row [2019 and 2020] when GDP fell by a third or more,” said Marcos Casarin, OE’s chief Latin American economist. “Given the magnitude of the collapse seen since 2014, Venezuela could grow at double-digit rates for several years in a row and still not recover its pre-crisis GDP level.”

Column chart of GDP change (%) showing Venezuela's economy has been shrinking for years

For every economist predicting growth, there are plenty who say Venezuela will suffer more pain before things finally improve.

FocusEconomics, a provider of economic consensus forecasts, recently polled 21 banks and consultancies for their views on Venezuela. The consensus was for a fall in GDP of 3.1 per cent this year followed by a rebound of 2.7 per cent next year. The IMF predicts a contraction of 10 per cent this year and 5 per cent next.

The huge differences between forecasts reflect uncertainty over the consequences of the pandemic, the impact and timing of the rollout of Covid-19 vaccines and the future of the sanctions regime.

“The evolution of US sanctions under the Biden administration remains the key determinant of the outlook,” wrote Stephen Vogado, economist at FocusEconomics.

The sanctions prohibit Venezuela from selling oil to the US and make it difficult for it to export elsewhere, although the government has found ways to get round the measures. Venezuela’s oil exports have risen slightly in each of the past five months, hitting a 10-month high in March — although they are still feeble compared with historical highs.

While oil has been the mainstay of the Venezuelan economy for the past century, the country also used to produce cacao, coffee and rice in significant quantities. It boasted a textile industry and produced chemicals, cement, steel and aluminium. Most of those industries have been decimated in the past two decades of revolutionary socialist rule.

At an outlet selling car accessories in a petrol station in the Las Mercedes neighbourhood of Caracas, store manager Alfredo Barrera said informal dollarisation had brought some degree of price stability after years of hyperinflation.

“The economy has adapted to the country’s problems,” he said. “Right now, it’s fair to talk about relative stability in terms of the currency but we’re a long way from seeing real improvement.”

At La Alicantina, a bakery that has been in business for more than 30 years, manager Douglas Palencia said sales had been hit hard by the pandemic. The shop’s windows, usually full of cakes and pastries, were empty. “I don’t have great expectations for this year,” he said.



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Sturgeon taps Scottish resentment over Johnson and Brexit

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Kenny Paton, the postman in Dumbarton, has been criss-crossing the west coast town near Glasgow, delivering flyers for all the parties contesting Scotland’s parliamentary elections this Thursday. But he is only listening to one.

For all the shortcomings of the Scottish National party’s 14 years in power, the recent turmoil surrounding its handling of sexual harassment claims against former leader Alex Salmond and the destructive nature of its cherished goal of breaking the 314 year union, the party is on course for victory once again.

That is in large part because the SNP, with first minister Nicola Sturgeon at its helm, has been speaking to the heart, tapping into the deep resentment many Scottish people feel at being ruled from Westminster by Conservatives whose leader Boris Johnson and policies, notably Brexit, they did not vote for.

Dumbarton, Scotland map

For some Scots, the economic arguments against independence — and these have only grown with the sharp deterioration in Scotland’s fiscal position since Brexit and the onset of the coronavirus pandemic — are no longer cutting through. 

“You can get into all the intricacies about the border and the currency but at the end of the day who do you want to run the country Boris Johnson or Nicola Sturgeon?” said Paton, who once supported Labour, but is now rooting for the SNP.

Nicola Sturgeon campaigns in Dumbarton © Jeff J Mitchell/AFP/Getty Images

If opinion polls in the run-up to Thursday’s vote are correct, the party is sure to remain the largest in the devolved Holyrood parliament and will possibly gain the slender majority it wants to continue pressing Westminster, for its second chance in seven years of winning independence in a referendum.

There is also the probability that with the Scottish Green party, and Salmond’s newly launched Alba party, the SNP will form part of a bigger block in favour of Scotland going its own way.

Chart tracking voting intention polls for the constituency vote in the Scottish Parliament election

But to get across the line to an SNP majority, Sturgeon may need to win marginals such as Dumbarton, where Jackie Baillie, the deputy leader of Scottish Labour and a popular constituency MSP is defending a majority of just 109, the most vulnerable in Scotland.

As well as her appeal to Scottish identity, Sturgeon has a number of other things in her favour. One is Labour’s weakness, and the perception that it could be long before the party Scotland once voted for en masse returns to power.

“I have been an advocate for Scottish independence since the Conservatives won a majority in Westminster. They do not reflect our views — Scotland is a progressive place,” said Ross Crawford, a 28-year-old IT consultant. “It will be a while before Labour can collect themselves — that’s what makes it so discouraging. It means yet more Conservative rule,” he said.

Labour’s Jackie Baillie in Dumbarton © Jeremy Sutton-Hibbert/FT

Most of all Sturgeon has Brexit and the indifference shown by first Theresa May, the former prime minister, and then Johnson to the majority in Scotland who voted to remain in the EU and who wanted to retain close relations.

“In 2019, the polls began consistently showing higher levels of support for the SNP. The rise occurs entirely among Remain voters,” said John Curtice, professor of politics at the University of Strathclyde. “Whatever the preferences of Boris Johnson, and Michael Gove [Cabinet Office minister], the brutal reality is that their pursuit of Brexit has undermined support for the union,” he said. 

Julie Reece: ‘We felt safe with her [Nicola Sturgeon] during Covid’ © Jeremy Sutton-Hibbert/FT

For most of last year backing for independence in Scotland polled at 50 per cent or higher when undecided voters are excluded. But while it has slipped back since then, support for Sturgeon in Dumbarton remains high. This has much to do with her more assured performance during the pandemic, which has helped the SNP avoid an awkward reckoning for its less than stellar longer term record in areas such as education and health. 

“We felt safe with her during Covid,” said Julie Reece, a bus company manager and former Labour supporter now backing the SNP.

Like many people strawpolled in the constituency, Reece was unfazed by Sturgeon’s alleged mishandling of sexual harassment claims against her former ally. “They have tried to make her a scapegoat for Alex Salmond’s affairs,” she said, adding, with a nod to how the first minister has brought women like her behind the SNP cause: “She has engaged women better — it switches you on that bit more,” she said.

But the stakes are high and the tightness of the contest is also galvanising Scots who support the union and are passionately against the rupture it would cause. This has led to unlikely alliances in Dumbarton, with some staunch supporters of the Conservative party even promising to vote tactically for Labour — a rare occurrence in UK politics.

Chart tracking voting intention polls for the regional vote in the Scottish Parliament election

“Anything that keeps the SNP out,” said Carl Vickers, who works at the Faslane naval base further up the Clyde estuary, where thousands of jobs could be lost if Scotland breaks away. The SNP opposes the use of Faslane to store the UK’s nuclear deterrent.

Vickers described himself as a Conservative by nature but said he would be voting for Baillie on the day.

“It’s all about stopping them [the SNP] getting another referendum,” said Trish Collins, a headhunter and Tory who was also planning to vote for the Labour candidate in the constituency vote, which the Conservatives have little chance of winning.

In Scotland, members of the parliament in Edinburgh are elected using a hybrid voting system: constituency representatives elected using the first past the post voting system while additional representatives are elected according to the proportion of votes a party secures in a region comprising several constituencies.

On the banks of the river Leven, Baillie herself remained defiant. “My seat on paper should go to the SNP but I am a seasoned campaigner so I am not stopping until polls are closed,” she said.

A pro-Scottish independence rally in Glasgow last Saturday © Jeremy Sutton-Hibbert/FT

“Our number one priority should be recovery and then we can argue about the constitution,” she added, warning that when Westminster pulls the plug on the job protection scheme, there could be a surge in unemployment.

“Brexit has been a mess,” said Baillie. “Leaving the UK could be 10 times worse.” 

That need to focus on recovering from the pandemic — the core of Labour’s campaign — does appear to have resonance, even among some SNP supporters. But for those already convinced about the risks involved in breaking up the UK union, the feelings were even more emphatic.

“We’d just got over one independence vote then Brexit was thrown at us. Now the SNP have got a good chance of coming out with a majority — the whole of Scottish politics is a joke,” said Bryan Burn, a wholesaler for fishing tackle.

He was speaking an hour south by car from Dumbarton in the relatively prosperous town of Ayr, where Conservative MSP and former farmer John Scott is defending another slender majority. A life-long Labour supporter, Burn was visibly distressed at the way things are headed. “If I were younger I would be looking to move elsewhere,” he said.

But Sturgeon is picking up votes in Ayr too.

“I like what she stands for. She’s great at what she does,” said Chris Hughes, a self-employed software engineer, who hoped an independent Scotland could rejoin Europe, and who along with his wife was voting SNP.

Scott, the Conservative incumbent who is defending a majority of just 700 votes, acknowledged that the odds were even. “It will be very, very close,” he said. “The independence issue has become an issue of the heart. Many people don’t take into account the grim realities it might hold for Scotland.”



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