How to measure investments’ sustainability? Some considerations on ethical rating

Admittedly, “finance” and “sustainability” are not terms that are easily juxtaposed. And yet, “sustainable finance” is not an ideal world, nor a niche sector, but a concrete reality that over the years is assuming a considerable weight in the financial context. According to the latest OECD report for 2019, the volume of “socially responsible” investments, i.e. those managed according to strategies aimed at rewarding choices with a positive environmental and social impact, has reached the threshold of 12 trillion dollars in theUSA and 14 trillion dollars in the EU area; figures that are inevitably set to rise following the COVID-19 pandemic, which has had the effect of making investors more aware of the importance of the “sustainability” issue.

A recent study commissioned by BNP-Paribas on the relevance of social considerations in the investment decision-making process showed that 81% of respondents among European investment funds and financial intermediaries takeenvironmental, social and corporate governance factors (ESG factors) into account. Virtually every investment fund, regardless of whether or not it avowedly pursues the objective of creating social value and can therefore qualify as a “socially responsible” fund, has therefore integrated into its risk assessment and management proceedings the analysis of these specific factors, which are capable of affecting the return on investment in the long term.

Thus, the question arises: how do we measure the environmental and social implications of an investment?

The answer would seem apparently simple: verifying what is the company’s attitude towards environmental challenges (Environment), whether it promotes human rights, how it enhances its human capital (Social) and, finally, whether the actions of administrative and control bodies are inspired by principles of correctness and legality (Governance).

A further doubt arises: what are the parameters to be respected for an investment to be considered “sustainable”?

Here all the knots come to a head, because, unlike financial risks, the so-called ESG risks cannot be estimated unambiguously, since there is no universally accepted definition of “sustainable investment”.

In practice, investment funds select deserving companies by entrusting the attribution of an ethical score to external companies, which adopt very different methodologies and standards. The impact of the investment from an ESG point of view is measured on the basis of criteria that reflect the interpretation given to the concept of “sustainability” by the individual rating agency or by the client (the investment fund), who can indicate to the consultant which aspects to consider (and which to exclude).

Ultimately, the rating given at the end of the evaluation phase to a given financial product (shares, bonds) does not express an objective judgment on its “sustainability”, but on compliance with what in the opinion of the investor or the agency are the requirements characterizing a sustainable investment. In many cases, moreover, the method used to formulate these judgments is not made public, which makes it difficult to compare the results; in addition, the evaluation processes may be influenced by situations of conflict of interest, since it is common practice for rating agencies to provide consultancy services for the subjects being evaluated.

Despite the fact that this lack of uniformity has led to the description of the sustainable finance ecosystem as a veritable “Wild West”, there are also experiences in this sector that deserve attention. This is the case, for example, of the Standard Ethics agency, based in London, the only company to deal exclusively with the assignment and monitoring of sustainability ratings, at the request of the issuers themselves. In particular, Standard Ethics stands out from its main European competitors on two counts: independence and method.

In order to preserve its autonomy, the agency does not provide consultancy services to the rated subjects, does not accept external certification procedures that limit its independence from a methodological point of view, and does not take part in lobbies, certification bodies or discussion groups where proposals to be submitted to international institutions are drawn up. These rules are anything but obvious for a rating agency and are certainly to be appreciated from the point of view of guaranteeing the impartiality of entities called upon to reduce information asymmetries between issuers and investors.

With regard to the method, however, the company expressly declares that it renounces any preconceived and subjective definition of “sustainable investment”, preferring to conduct its evaluations on the basis of sustainability standards derived from guidelines published by international organizations that promote the challenge of sustainable growth (United Nations; OECD; European Union; Council of Europe).

As pointed out by Standard Ethics itself in the document “Three Cornerstones of Sustainability”, is not for banks, investment funds and companies to decide what should be considered sustainable, but rather for democratic international institutions participated by nations, because“being sustainable means that both banks and businesses voluntarily align their activities with a collective, planetary effort, with well-defined strategies and objectives”.. Ultimately, only by verifying the adherence of the issuer to the strategies and policies of sustainable development shared at global level, resulting for example from the International Agreements of Paris on climate change, from the UN Global Compact for Migration, from the OECD Guidelines for multinational companies, from European regulations and from the Treaties of the Council of Europe, it is possible to achieve transparent and, above all, comparable results.

This also highlights the decisive role those international institutions could play in relaunching sustainable finance. In fact, there is no lack of market propensity to support and finance the process of transition towards a model of development that respects future generations; what is lacking are precise tools that allow financial operators to sort out what is effectively sustainable from what is not. The same institutions that have set sustainability objectives and identified the path to be taken to achieve them, have the competence and authority to channel financial resources towards entities that effectively contribute to the achievement of these results, establishing a framework of common rules to crystallize the minimum requirements to be met for a financial product to bear the “sustainable” label.

The European Union has recently moved in this direction, implementing the guidelines defined in the 2018 Actionplan on sustainable finance. In particular, the Taxonomy Regulation has the merit of clarifying what the conditions are for marketing a financial product as “eco-sustainable”, also binding financial market participants to inform investors about the alignment of the product offered with EU parameters.

These measures are undoubtedly encouraging, although insufficient: on the one hand, in fact, investors are provided with tools to measure only environmental impact, completely neglecting social and governance factors; on the other hand, EU legislation represents the response of only one part of the world to a problem that requires coordination at a global level.

Francesco Marotta

Insights

Capriglione, The post COVID-19: the need for sustainable development, in Nuove Leggi Civ. Comm., 2020, 5 – Supplement, p. 26 ss.

CONSOB, Sustainable finance, available at: https://www.consob.it/web/area-pubblica/finanza-sostenibile

Del Giudice, The sustainable finance. Strategies, market and institutional investors, Bologna, 2019.

Fondazione Finanza Etica, Ethical and sustainable finance in Europe, 2020, available at: https://finanzaetica.info/wp-content/uploads/2020/02/2020-RAPPORTO-IT.pdf

La Torre, Ethical finance and microfinance, voce del XXI Secolo, Treccani, Roma, 2009

United Nations Environment Programme Finance Initiative, Fiduciary duty in the 21st century, 2019, available at: https://www.unepfi.org/publications/investment-publications/fiduciary-duty-in-the-21st-century-final-report/