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How Institutional Investors Can Be Involved in Climate Actions

By navigating the complexities of SFDR, investors can reduce carbon footprints, support the transition and contribute to a more sustainable future, says Pedro Carvalheiro, Head of Capital Markets at HeavyFinance.

As the urgency to address climate change intensifies, institutional investors have a crucial role to play in driving sustainable practices and advancing climate actions. Because of rigorous standards, precise impact measurement methodologies, and pressure from supranational institutions, investments in the improvement of natural capital like soils, water, and other resources are on the rise.  

Nature-based solutions provide around a third of the climate action needed to achieve the Paris Agreement goals, and the urgency to act affords institutional investors an opportunity to put their money toward combatting climate change while seeking returns.

Given their holistic perspective on the economy and their focus on minimising risks, large institutional investors are highly interested in having exposure to natural capital, and especially so with in mind that insurers and state support for agriculture can mitigate risks of natural hazards like floods and droughts. 

Understanding SFDR classifications 

One of the key frameworks guiding investment decisions is the EU’s Sustainable Finance Disclosure Regulation (SFDR). Within the SFDR, Article 9 funds represent a significant opportunity for investors that look for rapid abatement and sustainable land use practices combined with strong returns on investment in the medium to long term.

SFDR offers three main classifications: Article 6, Article 8, and Article 9. Article 9 funds are considered the most sustainable, requiring portfolios with 100 per cent sustainable investments. The advantages of Article 9 funds lie in their ability to provide clear signals to investors regarding their commitment to sustainability. These funds attract environmentally conscious investors who seek to support climate-related initiatives while achieving financial returns.

Disadvantages and downgrades 

However, the transition to Article 9 funds has not been without challenges. In late 2022 and early 2023, a significant number of Article 9 funds were downgraded to Article 8 due to stricter regulatory guidance. This resulted in concerns over greenwashing accusations and uncertainty surrounding the interpretation of sustainable investments. Regulatory updates and lack of clarity on the definition of “sustainable investment” have left some fund managers hesitant to pursue Article 9 funds. These challenges highlight the need for further clarification and a more comprehensive review of SFDR to provide stability and confidence to the market. Additionally, it requires the faith of the largest fund managers. 

There is still much less capital allocated to Article 9 funds in comparison to Article 8, though, sufficient end-client demand promises that there will be an inflection point. Even if some market players are hesitant now, Article 9 funds present a great market opportunity to align positive impact with returns expectations. 

Asset owners and managers 

Despite the challenges, major asset managers have taken proactive steps to align themselves with climate actions. They have recognised the importance of integrating environmental, social, and governance (ESG) factors into their investment strategies.

Initiatives such as divestment from fossil fuels, engagement with companies on sustainability issues, and the launch of dedicated ESG funds demonstrate their commitment to driving positive change. These asset managers are also working towards reducing their own carbon footprint and exploring innovative investment opportunities.

EC efforts 

The European Commission acknowledges the need for further clarification and has been actively engaged in addressing the challenges surrounding SFDR. By providing clarifications and advocating for sustainable financial product labelling, they aim to combat greenwashing and protect investors.  

Any categorisation of sustainable investment products will have a significant impact on the market and drive demand for financial products fitting in a certain category. A clear and rigorous regulatory framework helps fund managers to avoid the risk of regulatory sanction and provide more assurance about Article 9 funds. The ongoing effort of the European Commission demonstrates a commitment to refining the regulatory framework and creating a more transparent and reliable system for investors. 

Continued demand for Article 9 funds 

Despite the downgrades and challenges faced by Article 9 funds, there is still substantial demand for these investment vehicles. Institutional investors recognise the significance of integrating sustainable investments into their portfolios.

Examples like Eurozeo launching Article 9 funds highlight the commitment of major players in the market to embrace sustainable practices and meet the growing demand for ESG-focused investments.

ESG-focused assets and agriculture

The global trend towards ESG-focused investments is expected to continue soaring. A PwC study suggests that ESG-focused assets under management could reach as high as US$4.5 trillion, indicating a strong market potential for sustainable investment products. Within this context, investments in the agriculture sector present a natural path to achieving sustainability goals.

Such investments can contribute to reducing emissions, sequestering carbon, and ensuring food security. Moreover, supporting organic farms and optimising sustainable agricultural output with new technology can have a positive impact on both the environment and the social well-being of small and medium-sized farming businesses.

Long-termism and carbon neutrality

Institutional investors, particularly pension funds, are well-positioned to adopt a long-term approach to climate actions. By aligning investments with a global strategy to become carbon-neutral, these funds can drive sustainable development. Article 9 funds that focus on carbon dioxide removal can effectively decrease their own carbon footprint, aligning with their long-term goals and contributing to a more sustainable future.

Institutional investors have a critical role to play in addressing climate change, and Article 9 funds provide a valuable avenue for their participation. While challenges and uncertainties remain, the commitment of major asset managers, ongoing efforts by the European Commission, and the continued demand for sustainable investments underscore the importance of institutional investors’ involvement in climate actions.

By navigating the complexities of SFDR and leveraging the opportunities presented by Article 9 funds, institutional investors can drive positive change, reduce carbon footprints, support sustainable agriculture, and make a meaningful impact on both the environment and society at large.

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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