Sustainable and responsible investment is gaining traction globally and is set to grow further in the coming years. Financial services providers face numerous challenges when offering solutions that meet their clients’ expectations in terms of sustainability. Knowledge and transparency are the watchwords.

Societies have undergone profound changes in recent years. Scientific studies and warnings from experts regularly highlight climate change, and its associated natural disasters have become daily topics of discussion. This theme, which is also driven by changing regulations, has finally percolated into the sphere of finance. “The expansion of sustainable and responsible finance over recent years is linked to the very evolution of society with regard to the issue of climate change”, says Mélanie Mortier, Senior Portfolio Manager at Banque de Luxembourg. “However, it is also a consequence of other important issues taking centre stage, such as gender equality and equality between people of different ethnicities, driven for example by the ‘Black Lives Matter’ movement.”

Sustainable finance fuelled by crises

Covid is another factor that has had an impact on the development of sustainable finance. “This crisis has highlighted a whole series of problems linked to our economic model, such as the need to source certain products from distant countries”, explains Mélanie Mortier. “Worker protection also became critical during the crisis, and companies that did the right thing in this regard stood out.”

Another crisis that could bolster the fight against climate change and play an unexpected role in the development of sustainable finance is the conflict in Ukraine. Apart from the humanitarian aspects, it has highlighted the dependence of European countries on energy supplies, especially from Russia.

“Governments are no longer just asking what they can do to counter climate change, but also where the energy they use comes from”, says the Senior Portfolio Manager at Banque de Luxembourg, who points to the European “REPowerEU” plan that is intended to save energy and diversify our energy sources. In this context, companies that offer alternative energy and develop less polluting solutions at a local level also have a card to play.

Integrating ESG criteria into financial analysis

ESG analysis of companies is complementary to the fundamental analysis of financial criteria. “Our aim is always to fully understand the company in which we invest, and in particular to measure all the risks which could affect it”, explains Mélanie Mortier. “There is no doubt that taking ESG risks into account gives us a deeper understanding of the companies in which we invest.”

Whereas historically, there was a strong focus on the environmental side of things, which is easier to quantify, now the social aspect is increasingly being taken into account. “This is obviously linked to how society evolves”, continues Mélanie Mortier. “Nowadays we aren’t just looking for ecological transition, we also want this transition to be fair.”

Harmonisation is necessary

Analysis of ESG criteria is based in part on the ESG ratings of companies, which in itself raises a raft of questions. The fact that these rating systems are not harmonised between the various data providers is fuelling the debate but also poses a problem in terms of the rating methodology’s transparency. “Tesla was excluded by S&P from its ESG index as it was disqualified by several factors (absence of a low carbon strategy, code of conduct, cases of racism and poor working conditions, etc.). However, MSCI, another major data provider, considered that the product proposed by Tesla was more important, in terms of sustainability than these other considerations”, Mélanie Mortier points out.

A year full of regulatory changes

The European Commission has an ambitious plan to promote the transition, including regulations to direct capital flows towards sustainable investments, improve transparency and integrate sustainability into risk management. In 2021, the Sustainable Finance Disclosure Regulation (SFDR) paved the way in this respect, with very clear effects. “In March 2021, 20% of European funds had declared themselves to come under Article 8 or 9 of the SFDR, i.e. promoting environmental or social characteristics to a greater or lesser extent. By the end of 2021, this figure had risen to 40%. This shows that the market has already adapted to the new regulatory situation and this is a trend that is set to continue”, says Mélanie Mortier.

Clarity for investors

For private banks, the changes are equally numerous and require efforts in terms of transparency and clients’ knowledge. “The challenge is to open the discussion with our clients and understand what they are looking for in terms of sustainability, so that they can take this into account in the management of their portfolios.” This process of discussion creates an opportunity to explain sustainable and responsible products. Reporting on investments also helps ensure maximum transparency. The challenge is to provide useful, understandable and relevant information. “As a committed bank, we support our clients in a responsible approach to their investments. We offer them sustainable and responsible solutions for a positive impact on society and the environment”, concludes the Banque de Luxembourg expert.