The future of European pension funds’ ability to talk about sustainability could hinge on sovereign bonds.
For many schemes, the viability of the new Sustainable Finance Disclosure Regulation (SFDR) will come down to how co-legislators decide to treat the asset class.
Under its planned redesign of SFDR, the European Commission wants to give minimal weight to the idea that government debt can contribute towards environmental and social objectives.
Its legislative proposal says that conventional sovereign bonds – those that finance general public spending – should be precluded from counting towards the 70% of assets required to qualify for two of SFDR’s planned new categories: Sustainability or Transition.
They would be permitted under the less ambition ESG Basics category if a credible methodology is used to integrate environmental and social issues into securities selection.
Deals with a dedicated ‘green’, ‘social’ or ‘sustainable’ label would be eligible under all three categories.
Crucially, government debt will be counted in the denominator of the calculation for all three categories, making it much harder for pension funds with significant exposure to sovereign bonds – in other words, all of them – to hit the 70% allocation to eligible assets.
PensionsEurope warned last week, that “labelling pension funds as ‘less ambitious’ [from a sustainability perspective] due to high sovereign bond exposure could create misplaced incentives and pressure pension funds to adjust investment strategies in ways that conflict with their fiduciary duties and the prudent person principle”.
Speaking to IPE, Andreea Lungu, a policy advisor for the organisation, said that, while it’s possible in principle to consider ESG factors when selecting government bonds, in reality, there’s a lack of robust methodologies, and the data is patchy.
“This makes it difficult to integrate sovereign exposures in a way that meaningfully reflects ESG ambition,” she continues.
As a result, PensionsEurope is calling for government debt to be removed as a consideration in all three categories, to ensure the asset class doesn’t stop funds with high sustainability ambitions from qualifying under the new SFDR regime.
“In essence, our approach states that government bonds should be included if a reliable ESG methodology or benchmark were adopted,” explains Lungu.
“But until such an approach exists, their exclusion from both numerator and denominator is the proportionate and pragmatic fallback.”
Meanwhile, Dutch pensions body Pensioenfederatie came out in support of the Commission’s proposal last week.
Matthies Verstegen, who heads its Brussels office, describes government debt as “a make-or-break issue for pension funds’ ability to comply with the ESG Basics category”.
“Under the current approach, categorisation looks attainable,” he tells IPE.
But that could be derailed during upcoming negotiations with co-legislators, which are likely to see the topic become a target for political wrangling.
That’s partly because member states will be conscious of how their own issuance will be treated under the framework: governments are unlikely to pass rules that make them less attractive to investors.
They may also be keen to avoid a regime that promotes the direct comparison of their sustainability credentials with other countries.
And there is potential for the issue to become a battleground for progressive politicians and campaign groups keen to ensure the final SFDR is ambitious.
Conventional sovereign bonds are used to finance general public spending, which may include harmful projects as well as those that support a country’s green and social goals – there is no ringfencing mechanism that allows a distinction to be made.
As a result, and to avoid the risk of greenwashing, some stakeholders are likely to argue that the asset class should be deemed ineligible under all three SFDR categories.
“That would set a bar pension funds simply cannot reach, while still limiting how they can communicate to their members about responsible investment,” claims Verstegen.
“We urgently call on the European Parliament and Council to follow the Commission’s proposal on this matter”.
