While the rise of environmental, social and governance (ESG) investing has been instrumental in the success of the fossil fuel divestment movement so far, critics argue that recent changes to the European Union’s ESG taxonomy threaten the current momentum.
Earlier this year, the addition of natural gas to the EU’s list of sustainable investments was met with a fierce backlash from environmental campaigners and even provoked the threat of legal action from the campaign group Greenpeace. As a result of the changes, it becomes easier for funds exposed to the fossil fuel industry to be designated as Article 8 or Article 9 compliant under the EU’s Sustainable Finance Disclosure Regulation (SFDR).
But if ESG funds can’t guarantee that money isn’t being used to finance the fossil fuel industry, how can environmentally-conscious investors looking to decarbonize their portfolios avoid investments that are exposed to these carbon-emitting sectors?
Thankfully, providers of regulatory technology (RegTech), often the very same companies that help financial institutions manage their compliance procedures, also have a set of tools that can be applied to the challenge of fossil fuel disclosure.
RegTech for ESG Compliance
For investors and asset managers, the need to comply with legislation such as the SFDR has led to the development of innovative accounting frameworks and new data tools.
Building a detailed picture of the carbon emissions and fossil fuel exposure of complex financial instruments requires data that extends across both the financial data that RegTechs and rating agencies have always mobilized, as well as alternative datasets that have not traditionally been exploited.
These include industrial information, ESG reports, corporate relations data and various third-party datasets.
One key challenge in this regard is connecting financial and environmental information at the micro-asset level all the way through complex financial systems to the ultimate asset owner.
To meet this challenge, RegTechs have been increasingly developing tools to allow carbon monitoring and tracking. Established firms in the space like Moody’s, S&P and MSCI have all built their own ESG ratings tools, while more niche players have also built solutions for investors looking to get a better understanding of their portfolios.
Other exciting prospects include the application of blockchain and smart contracts to create greater transparency and verifiability in companies’ reporting processes and to mitigate against greenwashing. This approach has been pursued by Chinese firms VeChain and WeBank.
But ultimately, ratings tools need transparency in order to work and efficiently monitor carbon emissions and fossil fuel exposure. In this area, another layer of data aggregators is needed to plug the necessary information into ESG and carbon monitoring tools.
For example, Carbon Tracker and Global Energy Monitor (GEM) have the Global Registry of Fossil Fuels (GRFF), an accessible and open-source database that brings thousands of government and corporate information sources together into one place.
While projects like the GRFF are helping to introduce transparency into global fossil fuel supply chains, and innovative RegTechs are building the tools to map asset ownership in complex global investment networks, investors and asset managers are still often left basing their decisions upon abstract metrics and a reporting system that relies heavily on carbon credit trading to balance the CO2 books.
For those looking to completely remove fossil fuels from their portfolios, funds that provide guarantees against exposure to oil and gas remain one of the most attractive investment options.
More transparency will always help investors make informed decisions, helped along by the various information aggregators and ESG monitoring services that help decisionmakers understand the array of information that is out there.
To this end, the SFDR is a valuable tool in the battle against climate change, but only if investors take a holistic view of the information available rather than relying on pre-defined investment categories and regulatory taxonomies.
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