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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

Investors lambast Sunak’s plans to raise corporation tax

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Shareholders have hit out at the British government’s plans to raise the UK corporation tax rate and warned it could make the country a less attractive place for investment.

Chancellor Rishi Sunak on Wednesday set out plans to increase the corporation tax rate from 19 to 25 per cent for larger businesses in 2023 — the first time it will have been raised since 1974.

The Treasury estimates the move will raise £17bn in 2025-26, but investors expressed concern because of how it could reduce dividend payments by companies.

Richard Buxton, fund manager at Jupiter, an investment group, said Sunak’s proposed increase in the corporation tax rate amounted to a “sizeable bite” out of businesses’ profits.

“When looking at potential profits over a three to five year time horizon investors will have to factor this in, and it will erode earnings and potential dividend growth,” he added.

“In turn, this may at the margin reduce the attraction of UK equities to both domestic and international investors.”

The UK is one of the world’s most popular financial markets for income-seeking investors.

Tom Stevenson, investment director at Fidelity International, a fund manager, said Sunak’s increase in the corporation tax rate would leave the UK just about competitive “but shareholders in the largest, listed companies that will bear the brunt of the measure will not welcome this”.

David Page, head of macro research at Axa Investment Managers, another investment group, said he expected more countries to raise corporation tax rates like the UK, but added: “Does this make the UK less attractive? At the margins yes.”

Nigel Green, chief executive of deVere Group, a financial adviser, said Sunak’s move “will reduce profit after tax and slash the profit available for dividends. This will not go unnoticed by those looking to invest in the UK”.

Sunak said in his Budget speech in the House of Commons that even after his corporation tax reform, the UK’s headline rate would still be the lowest among G7 nations.

But experts said the UK does not look as competitive internationally on other measures, because it is much less generous than other countries — including France and Germany — in the share of capital spending that companies are allowed to set against taxable profits.

An OECD measure of the effective marginal corporate tax rate — the amount of tax a hypothetical company pays on an extra pound of profit — shows the UK is close to the average among developed economies now, but could have one of the toughest regimes among the international organisation’s member nations after 2023.

“The headline rate is not the only thing that matters . . . Mr Sunak is taking a gamble that raising corporate taxes further up the international pecking order won’t have too terrible an effect on investment,” said Paul Johnson, director of the Institute for Fiscal Studies.

Corporation tax rise will give UK relatively high effective rate. Chart showing Effective marginal corporate tax rate, 2019 (%). With the increase in UK's corporation tax in 2023 it will be behind only Australia, Spain and New Zealand in the OECD with the Effective marginal corporate tax rate

The IFS said the extra revenue stemming from the higher rate of corporation tax would in the long run be less than the government’s £17bn a year estimate.

A higher rate would reduce incentives for companies to make investments that would increase profits in later years, it added.

Sunak said on Wednesday the majority of businesses would avoid the corporation tax reform given a rate of 19 per cent would apply to businesses making profits of less than £50,000 each year.

He added the rise in the corporation tax rate to 25 per cent for larger companies in 2023 will be preceded by a new allowance for capital spending, providing a “super-deduction” of 130 per cent on new plant and machinery. 

Dan Neidle, a partner at the law firm Clifford Chance, said the two year tax break would be a strong incentive for companies to accelerate investments that were in the works, although it was not long enough to generate new capital spending that took time to plan.

Tax campaigners TaxWatch UK also criticised the move, saying it would give a tax break to companies that have thrived during the pandemic, including Amazon.

Analysis by TaxWatch found Amazon Services UK, an entity that provides warehousing and delivery services, would have its corporation tax bill wiped out based on its last reported spending on plant and machinery. Amazon declined to comment.

Several smaller companies announced they would bring forward investments as a result of Sunak’s proposed tax break, although larger businesses including defence manufacturer Meggitt said that it would be more difficult to change long term plans.

Tony Wood, chief executive of Meggitt, said the company made “decisions on where to do [the] engineering effort based on what is right for the decade rather than what is right for the two year timeframe”.

But Gavin Cordwell-Smith, chief executive of Hellens group, which owns a paving slab manufacturer in Sunak’s Richmond constituency, said that “as a direct consequence of the [chancellor’s super deduction] announcement, we have already decided to accelerate our growth plans, including a new production line”.

Chemicals maker Christeyns will also bring forward investment plans — and likely increase them — in three factories, said director Nick Garthwaite. 

Some business leaders expressed concern at how Sunak’s planned tax break would only last two years, and be immediately followed by the increase in the corporation tax rate to 25 per cent.

“The chancellor wants a two year investment boom, but we will then go from feast to famine at a time when the consumer recovery might be tailing off,” said one executive.

Additional reporting by Sylvia Pfeifer in London



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China’s leaders focus on post-Covid economy at annual meeting

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China’s National People’s Congress, the country’s annual rubber-stamp parliament session, will convene on Friday for a meeting set to focus on a problem many other countries wished they had: how to rein in an economy that has rebounded from the coronavirus pandemic.

“There have been intense discussions about monetary and fiscal policy,” said Wang Jun at the China Center for International Economic Exchange, a government think-tank in Beijing. “The primary goal is to stabilise leverage, but if policy [tightening] goes too far too quickly it may have a negative impact on financial markets as well as the real economy.”

The NPC will run for about a week and is typically a forum where previously agreed measures and policy objectives are formally approved. Last year’s session, however, was dominated by Chinese president Xi Jinping’s surprise announcement of a stringent national security law for Hong Kong after the city was rocked by anti-government protests in 2019.

The gathering also provides the biggest stage of the year for Xi to project his unchallenged grip on both the government and the Chinese Communist party as he prepares for an unprecedented third term in power in late 2022.

China’s post-Covid recovery contrasts starkly with the situation in the US, where the pandemic has claimed the lives of more than 500,000 Americans and President Joe Biden is pushing Congress to pass a $1.9tn economic stimulus package.

China annual GDP growth rate 2018-2020

Guo Shuqing, one of China’s most powerful financial regulators, warned this week about the dangers of “extremely loose monetary policies” in the US and other pandemic-wracked economies, saying the measures could cause “too much fluctuation” in Chinese financial markets.

He added that China’s property market was still afflicted by “relatively large bubbles” and suggested lending rates would “rebound” this year. Guo, who heads the banking regulator and is also the most senior party official at China’s central bank, pronounced late last year that the real estate sector was the country’s “greatest grey rhino in terms of financial risk”.

Guo’s comments sparked a sell-off on regional markets, illustrating the difficult balance he and other financial officials must attempt to strike. Stimulus measures rolled out by Chinese president Xi Jinping’s administration early last year helped spur investment but also propelled debt levels in the world’s second-largest economy to about 270 per cent of GDP.

“While the leadership feels confident about the economy’s trajectory, there is still a lot of uncertainty,” said Andrew Polk at Trivium, a Beijing-based consultancy. “Authorities need to find a way to unleash consumption and pick up slack from industrial production and real estate investment.”

Shuang Ding, chief China economist at Standard Chartered in Hong Kong, said Beijing was likely to reduce its budget deficit to 3 per cent of GDP, down from 3.6 per cent last year. But he also forecast the Chinese economy would grow at least 6 per cent year on year, with “substantial room for outperformance”, and create 11m jobs.

“The most pressing economic issues are how to withdraw from last year’s expansionary fiscal policy and how to increase consumption,” said Jia Jinjing, an economics professor at Renmin University in Beijing. “The central deficit budget will be lower than last year but still above 3 per cent. We cannot rely too much on increased debt to spur consumption.”

China retail sales growth

NPC delegates will also formally pass the party’s 14th five-year economic plan, which is focused on achieving “self-reliance” in a number of critical technology sectors as well as ambitious environmental goals, including reaching peak carbon dioxide emissions by 2030 and net-zero emissions by 2060.

The NPC session in 2020 was delayed for almost three months by the pandemic and fixated on the imposition of the national security law on Hong Kong.

This year, it is likely to approve measures that will further reduce the pro-democracy camp’s representation in the city’s legislature. It is also expected to unveil rules consolidating Beijing’s hold on an already pro-establishment “election committee” that chooses Hong Kong’s chief executive.

Dozens of Hong Kong democracy activists, including publisher Jimmy Lai and jailed student leader Joshua Wong, have been charged with alleged offences of the security law. In a speech last month, Xia Baolong, head of the Chinese government office responsible for Hong Kong, singled out Lai and Wong as “extremely vile anti-China elements”.

“There doesn’t seem to be any end to the crackdown,” said Willy Lam, a China politics expert at the Chinese University of Hong Kong. “Xi has made up his mind to snuff out Hong Kong’s opposition movement altogether. For ordinary people, Beijing will insist on ‘patriotic education’ in the schools and media.”

A Chinese academic who advises Beijing on Hong Kong issues said the territory had been “too unbridled” prior to last year’s passage of the national security law. “The central government had no other option,” said the academic, who asked not to be identified. “The Hong Kong opposition overestimated its power.”

Additional reporting by Xinning Liu in Beijing



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Sunak goes big and bold to try to repair the public finances

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Chancellor Rishi Sunak’s Budget was big, bold and broke many longstanding records for the public finances.

At an estimated £355bn, the level of UK government borrowing forecast for 2020-21 is due to be the highest since the second world war, reflecting the severity of the coronavirus crisis. It highlights the sheer scale of emergency state support for companies and households during the Covid-19 pandemic.

The tax rises announced on Wednesday by the Conservative chancellor for the middle of the decade — affecting businesses and individuals — will be the largest since 1993. The increases will raise the UK tax burden to its highest level since Roy Jenkins was the Labour party chancellor in the late 1960s.

Justifying his approach, Sunak told the House of Commons: “Just as it would be irresponsible to withdraw support too soon, it would also be irresponsible to allow our future borrowing and debt to rise unchecked.”

As far as the public finances are concerned, the March 3 Budget will become known as a “give then take” affair that will reshape the relationship between the state and the private sector for many years ahead.

And the figures in the Budget documents confirm the coronavirus crisis has utterly transformed the public finances for the worse.

At the March 2020 Budget, when the UK had little clue about the enormity of the pandemic, the Office for Budget Responsibility thought the government would borrow £55bn in 2020-21.

Sunak, who unveiled a £12bn support plan for the economy in what was his first Budget, has since had to add huge amounts of public spending in 16 major announcements.

On Wednesday, he outlined another £40bn of support, bringing total spending to £344bn, according to the OBR: roughly 16 per cent of gross domestic product, and well above the average of 13.3 per cent among advanced economies.

Chart showing the 16 major announcements since the last Budget have increased coronavirus support

It is this spending, alongside a loss of £90bn of expected tax revenues, that is set to raise the level of government borrowing to the highest level in peacetime.

In 2021-22, the government is still planning to spend £93bn on virus related support, mostly going to the NHS, but with large sums also for continued support for companies and households.

Karen Ward, strategist at JPMorgan Asset Management and a former adviser to Philip Hammond when he was chancellor, said Sunak was wise to keep splashing the cash in the next financial year. “The chancellor has rightly erred on the side of an extension that is potentially too long, rather than one that is too short,” she added.

With the colossal borrowing, underlying UK public debt, excluding temporary Bank of England schemes, is set to jump from a pre-pandemic forecast of 73 per cent of GDP by the middle of this decade to 97 per cent in the latest OBR prediction.

The 24 percentage point rise in the core debt burden is the second large jump in a little over a decade following the fiscal shock associated with the 2007-08 financial crisis. At about 100 per cent of GDP, UK public debt is now at its highest level since the early 1960s, when it was gradually coming down following the second world war.

Chart showing that public debt is set to rise to levels not seen since the early 1960s

This Budget was not just about fiscal support in 2021-22, but also stimulus to power the recovery, according to Richard Hughes, OBR chair. He said Sunak’s £25bn “super-deduction” in corporation tax would “stoke the recovery” and “encourage businesses to bring forward future investment into the next two years”.

But after 2021-22, the giveaways stop, and Sunak becomes the revenue raising chancellor, with very large increases planned in corporation and income taxes.

The moves risk damaging the UK’s international standing. In 2018, the OECD said the UK taxed corporate profits below the rich country average. Britain collected 2.6 per cent of national income through the levy, compared with the OECD average of 3.1 per cent.

By 2025-26, the OBR projections suggest UK corporate taxes will generate revenues above the OECD average, although Hughes said this level was “one [the UK] seldom sustained for very long in the postwar period”.

Paul Johnson, director of the Institute for Fiscal Studies, a think-tank, said Sunak’s corporation tax rise was a significant risk. “For all the rhetoric about it leaving the headline rate here below that in other G7 countries, our effective tax rate will be relatively high,” he added.

The tax rises will tackle the high level of borrowing, however, according to the OBR.

It projects the increases will lower the current budget deficit in 2025-26 from £37bn, had Sunak done nothing, to £1bn, almost balancing the government’s books excluding public investment. This is a core ambition of ministers.

Chart showing Rishi Sunak’s spend then tax Budget to balance the books

Some economists thought Sunak should have been more explicit in setting new targets for the public finances.

Hande Kucuk, deputy director of the National Institute of Economic and Social Research, a research organisation, said the Budget needed “a comprehensive fiscal framework to build confidence in a sustained recovery given the significant uncertainty regarding the long-term effects of Covid-19 and Brexit”.

Other economists were more forgiving since there are huge uncertainties hanging over the public finances. The path of the pandemic is perhaps the largest, but Sunak also has to worry about the possibility of increased debt servicing bills if interest rates rise, and whether he can cut spending as he plans when the virus subsides.

Torsten Bell, director of the Resolution Foundation, another think-tank, was sceptical the chancellor would be able to reduce departmental spending.

The Budget documents showed a stealthy £4bn a year cut in spending alongside the tax rises. “He’ll end up spending more than that,” said Bell, adding this would add to pressure to proceed with additional tax rises.

But Sunak is an optimist, and hopes the uncertainty will go in his favour. If the economic recovery is sufficiently rapid, the chancellor will be looking to the OBR to cut its estimate of a 3 per cent long term hit to the economy from coronavirus.

And if that happens in a future Budget, Sunak can look forward to the possibility of tax cuts before the next general election.



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