The lack of common standards has long been a major issue when it comes to the development of environmental, social and governance (ESG) investing. But recent proposals by the European Parliament for a sustainable finance taxonomy that would pave the way for common ESG investment standards are raising concerns among investors.
The proposed sustainability taxonomy, drawn up in Brussels last month, is basically a regulatory framework for establishing which economic activities substantially contribute to ESG objectives. To be fair to the EU, the rationale for the establishment of a sustainable finance taxonomy is commendable since it will set certain standards that have to be met before a financial product can qualify as a sustainable investment.
But there are concerns that its implementation at this time, when ESG investing is still evolving, particularly in Asia, may not be compatible with the fast-evolving nature of sustainable investments. Fears also exist that the sustainable finance taxonomy may result in over-regulation, eventually stymying the highly-innovative and creative aspects of ESG investing.
At present, there are a proliferation of ESG scoring/rating systems drawn up by various asset managers, index providers, and specialist entities, including MSCI, FTSE, Sustainalytics, RobecoSAM, and UBS.
The rating/scoring systems help investors identify the level of ESG compliance by specific corporates (whose securities they invest in). MSCI’s methodology, for example, examines 37 ESG-linked issues and ranks them from 0 to 10.
But while these scores provide a basis for building an ESG-focused portfolio, they fail to answer the bigger picture. In particular, what characteristics should make up a portfolio that follows an ESG rating system.
This unanswered question, plus the proliferation of ESG scoring/rating systems, has, in some cases, resulted in confusion among investors, especially those who are new to ESG investing.