Industry bodies align on key sustainable finance-related definitions to offer end-users greater “consistency and clarity”.
As investors’ approaches to ESG and sustainability-focused investing become increasingly varied, there is greater need for consistency and clarity across related terminology to avoid confusion and prevent greenwashing.
“Over the past decade, an increasing number of investors have become interested in investment products that align with their personal values or societal goals,” Chris Fidler, Senior Director of Global Industry Standards at the CFA Institute, told ESG Investor.
“During the same period, there has been an explosion in the availability of information related to environmental, social, and corporate governance practices.
“The combination of these factors enabled the investment management industry to develop new approaches and enhance existing ones.”
With fund managers developing their own definitions and strategies for their products, this makes it more difficult for end-users like asset owners to compare ESG-labelled funds effectively and identify best performers.
In October, the European Securities and Markets Authority (ESMA) published research which showed funds with an ESG-related label attract higher inflows. The growing use of ESG-related language in fund names and documentation without transparency and underlying evidence increases greenwashing risk, ESMA warned.
In November 2021, the International Organization of Securities Commissions (IOSCO) said there is need for the global investment industry to “develop common sustainable finance-related terms and definitions” to ensure consistency.
To address this, on 1 November the Global Sustainable Investment Alliance (GSIA), UN-convened Principles for Responsible Investment (PRI) and CFA Institute published a report outlining aligned definitions for five terms: screening, ESG integration, thematic investing, stewardship, and impact investing.
The joint report recognises the need for “much greater consistency and clarity over defining a variety of sustainable and responsible investment approaches in today’s market”, James Alexander, the GSIA’s Chair and CEO of the UK Sustainable Investment and Finance Association (UKSIF), told ESG Investor.
The starting point for the work undertaken by the GSIA, PRI and CFA Institute was to consider existing definitions within the industry and “find points of convergence and points of difference”, according to Eilidh Wagstaff, Senior Specialist in PRI’s Investor Guidance Team.
“From there, it was a case of working out how to align in a way that was clear,” she said.
Each definition includes a detailed explanation, a list of definitions from organisations that served as the primary inputs, and additional guidance for utilising these definitions in practice.
It further aims to counter confusion about what these responsible investment strategies seek to achieve, differentiating the objectives of the approaches, such as ESG integration versus impact investing.
“It was also important to keep the definitions straightforward,” said Wagstaff, noting that – especially for retail investors – it is vital that the end-user isn’t “bamboozled with jargon”.
To aid clarity, rather than listing criteria for product-labelling or categorisation, the document has attempted to describe the concepts that define each responsible investment approach, which Wagstaff said “allows for an element of flexibility”.
The GSIA, PRI and CFA Institute have defined ‘screening’ as a process for determining which investments are or are not permitted in a portfolio.
Screening rules can be based on qualitative and quantitative criteria, the report noted, such as whether the issuer is a constituent of a specific ESG-related index or whether more than 10% of an issuer’s revenue is from the production and/or sale of tobacco products.
“Thresholds are an essential element of any quantitative screening criteria,” the report said, noting that thresholds can be absolute, relative, or relative to peers. As an example, it noted that an investor with a Scope 1 CO2 emissions screen may use carbon neutrality (absolute threshold), 200 tonnes per US$1 million of revenue (relative threshold), or the industry average carbon intensity (relative to peer thresholds).
These updated definitions are also applicable beyond listed companies.
“It was important that we made sure that we understood and focused on the essence of what each approach was about and ensure [our definition] is suitably applicable across different types of investment strategy and asset classes in both public and private markets,” said Wagstaff.
Toby Belsom, Director of Investor Practices at the PRI, noted that this work is “unlikely to halt greenwashing in and of itself”, but it should nonetheless serve as “a very useful tool to help investor members ensure they are providing a clearer picture on what they are doing and not fall into presenting information about products in a way that’s misleading”.
Alexander from UKSIF said the three organisations are “optimistic” that the report will serve as a valuable contribution to regulatory authorities and the investment industry’s ongoing efforts to “create a more common language” around sustainability-focused investing.
“We hope it will support global policymakers’ ‘live’ discussions on their approaches to disclosures regime and fund labelling – whether in the UK, EU, US and elsewhere – in particular, assisting in harmonisation of approaches which remains critical for industry and the clients they serve,” he added.