Action Needed to Scale Up ESG Investing, say IMF, OECD

IMF, World Bank and OECD working on classification systems to harmonise and support the development of sustainable finance markets.

Governments and investors have been urged to do more to help spur the US$20 trillion investment needed to enable the transition to net-zero greenhouse gas emissions over the next two decades.

Despite much progress having already been made, reforms must be put in place to further accelerate sustainable investing, according to new reports from the OECD and IMF.

The OECD’s ‘ESG Investing and Climate Transition’ report said that while ESG investing had become mainstream in a number of its jurisdictions, there remain considerable barriers to its ability to support long-term value and climate-related objectives.

These included the “promulgation of different approaches, data inconsistencies, lack of comparability of ESG criteria and rating methodologies, as well as inadequate clarity over how ESG integration affects asset allocation”.

In addition, strong fiscal, regulatory and financial policies are needed to support the growth of sustainable investing, alongside more action from the world’s US$50 trillion investment fund industry, according to a dedicated chapter of the IMF’s new Global Financial Stability Report.

Small fraction

The IMF found that net flows into sustainable funds notably increased last year, with investment funds also stepping up proxy voting on climate-related matters, especially those with a sustainability focus, suggesting a positive contribution to the transition to a low-carbon economy.

However, it added that sustainable investment funds still represent only a small fraction of the investment fund universe.

At the end of 2020, funds with a sustainability label totalled about US$3.6 trillion, representing only 7% of the overall investment fund sector. Funds with a specific climate focus accounted for a “meagre” US$130 billion of that total.

The IMF called on governments to strengthen the global climate information architecture, including data, disclosures, and sustainable finance classifications, both for firms and investment funds.

“Better classification systems for funds, where fund labels and taxonomies are uniformly used and understood, helps to summarise a fund’s investment strategy and its overall approach to engagement and stewardship,” said the report authors in an accompanying blog. “Our analysis shows that labels have become an increasingly important driver of fund flows – especially in the retail segment of the market.”

To this end, it said that it, together with the World Bank and the OECD, aims to develop principles for such classification systems to harmonise existing approaches and support the development of sustainable finance markets.

The IMF also called for proper regulatory oversight to prevent “greenwashing,” and tools to channel savings toward funds that enhance the transition. This could include enhanced eligibility of climate-themed funds for favourable tax treatment in savings products such as retirement plans or life insurance products.

In calling for greater policy action, the IMF noted that “COP26 could be a watershed moment for much needed global
climate policy actions to reverse the trend of growing emissions and mitigate climate change”.

Transparency and precision

In its report, the OECD outlined a series of measures to boost investment, including regulation of ESG ratings.

It stated that the ratings often lack transparency, differing substantially in the metrics on which they draw, as well as the methodologies used in their calculation, raising questions as to the extent to which their aggregation contributes to long-term value.

Methodologies also tend to differ substantially across rating providers, it added, resulting in a lack of correlation between them.

“Policies are needed to ensure global transparency, comparability and quality of core ESG metrics in reporting frameworks, ratings, and definitions of ESG investment approaches,” it said.

IOSCO, representing securities regulators, has also called for stronger regulation of ESG ratings. The European Commission unveiled plans for regulation in July as part of an update to its Sustainable Finance Strategy.

The OECD said rating providers appear to place less weight on negative environmental impacts, placing greater importance on disclosure of climate-related corporate policies and targets, with limited assessment as to the quality or impact. Such limitations could hinder the use of ‘E’ pillar scores by investors to align portfolios with the low-carbon transition, it warned.

The report called for greater transparency and precision of the meaning of sub-category scores so metrics could contribute to better alignment of E pillar scores with a specific purpose, such as assessment of climate transition risks and opportunities, or broader environmental impacts.

Such clarity would allow investors with specific sustainability goals to use ESG approaches as a more effective tool for portfolio rebalancing and risk management, it added.

The OECD also called for policies to foster transparency and comparability of ESG investment approaches, as well as to strengthen the tools and methodologies that underpin disclosure, valuations, and scenario analysis in financial markets associated with a low-carbon transition. Other recommendations included frameworks utilising standardised core metrics to form baseline reporting for the E, S and G pillars for use by market participants.

The report said disclosure practices based on the recommendations of the Task Force on Climate-related Financial Disclosures should be strengthened to improve granularity, reliability and interoperability of metrics with respect to climate metrics, targets, and transition plans.

In addition, the OECD recommended greater transparency and clarification of the stewardship plans and policies of major asset managers and institutional investors in their engagement with boards and executive management on the reduction of climate intensity and commitment to emissions targets.

Transition “hampered”

The OECD report on ESG investing was accompanied by a separate report, ‘Financial Markets and Climate Transition’, which stated that although market participants understood the importance of a low-carbon transition, “current progress and the effective market pricing of positive and negative valuation impacts of a transition is hampered by insufficient data”.

This includes financially material metrics and analytical tools to measure and manage transition risks, including the lack of policy clarity and consistent sectoral coverage of carbon pricing and support for low-carbon and renewable alternatives. The report said that market products such as bonds or structured products and measurement tools including ratings and indexing also need to further evolve.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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