Acceptance of nuclear and gas to the taxonomy risks the flow of ESG Impact capital to the E.U. market.
The E.U. had been leading the climate change debate and was on the verge of attracting significant capital flows to the block. Now investors are not so sure.
Unintended consequences
The direction set by politicians, regulators and governments plays a crucial role in enabling long-term investment and capital flows to meet Paris agreement targets. The E.U. decision to allow nuclear and gas to the green finance taxonomy runs counter to the principles and effectiveness of developing capital markets which will close the liquidity gap required to drive the circular economy.
Short term motivation
The motivation to achieve energy security is understandable. Unfortunately, the unintentional outcome is to take capital flows away from the technologies and energy solutions that will deliver long term energy security aligned with climate science.
All capital operates the same
ESG and impact capital is a subset of the larger capital markets. The intention is to match green-tagged capital so it flows to innovative companies and technologies that will reduce negative planetary impact. Innovative capital markets require frameworks, standards, and mechanisms that reduce investors’ aversion to risk. The direction setting is critical to the flow of capital, justifying organisations’ investment in political lobbying and influence.
Sovereigns need to go big or go home.
Forty years of neoliberal economic theory creates a legacy and ideological entrapment. When coupled with the fear of leveraging sustainable linked bonds to create markets and drive innovation, western governments are economic eunuchs unable to conduct or direct investment in critical sectors to drive the circular economy. So far, European governments have issued €145bn of green bonds to only around 10% of all green bond issuance. France is the largest advanced economy issuer; green bonds make up only 1.9% of its debt stock. Little impact will come from this level of capital sovereigns need to step up, step in and put capital into the sectors that count.
Bad Timing
Research released on June 28th, 2022, by PWC [after the wave of greenwashing scandals] indicated that 66% of European institutional investors plan to stop investing in non-ESG funds. 72% were willing to pay a premium for ESG assets, allocation under E.U. Article 8 of the SFDR is forecast to increase to 68% by 2025, and 72% of European Asset managers are considering halting non-ESG products by the end of 2025. The parliament’s decision will not help these trends or speed up investment decisions.
The focus is on the future.
Throughout 2022 my conversations with large and small investors, asset owners, CFOS and CEOS follow the same themes. At a macro level, the view is that the commodity and fossil fuel bubble is the short run. Demand for assets is in the market. Chastised by the recent ‘greenwashing raids, ‘ investors and P.E. firms have been sensing the game is up in presenting questionable assets as ESG.
Science-based measurements
Analysts and researchers seeking to construct portfolios frustrated with current marker tools, are asking more questions about science-based targets over ESG ratings. As a result, interest is high in sectors that align with the SFDR and green bond principles, including hydrogen, energy efficiency, batteries, services sectors of renewables, sustainable agriculture, and plant-based food.
Big funds are still missing on innovation
Investors are seeking how to build portfolios which are ESG and impact compliant. At the same time, their investment committees still block more significant funds and investors from chasing the genuine innovative part of the market below $500m. Nevertheless, the interest and the willingness to take risks from family offices, smaller funds and individuals have been tangible.
Halt of capital flows
While hindering the transition to a low carbon economy, the real impact of the E.U. parliaments decision will be on capital flows from mid-cap funds and investors to the firms developing innovative offering solutions for the circular economy. Without these firms, the E.U. cannot lead economic regrowth, wealth and job creation based on low carbon, climate, and biodiversity impact.
Von Der Leyen needs to lead.
The defence of the new energy taxonomy by Ursula von der Leyen, European Commission president, will not help investor trust. Nor does it help address the central challenge capital markets participants face, which is the inability of sections of the financial markets to align capital with science-based target timelines. Nevertheless, I am a fan of Von Der Leyen, and I think she and her team have achieved a lot. When required, she has demonstrated she can be decisive. Now is the time to redouble efforts and drive critical changes.
We’ll get there in the end.
J.M.
I am a consultant working with CEOS, CFOS, the boards of companies and investors in the ‘real economy’ who need to respond and develop a coherent strategy to the ESG transition. In a rapidly changing world, I support them define their ESG purpose, vision, and mission, which is critical to their long-term success, valuation, and profitability.
