The debate about sustainable finance is often framed around disclosure, stewardship and product design. Research I recently conducted revealed that the real test for constructing or selecting a good sustainable portfolio could centre around one simple question: “Where should we never invest?”
Recently published by the University of Buckingham, my paper examined whether sustainable funds classified under SFDR Articles 8 (“light green”) and 9 (“dark green”) helped equip the Russian regime over the six months before its full-scale invasion of Ukraine in February 2022.
Data sourced from Morningstar Direct revealed that, over that period, at least 391 European sustainable funds invested in Russia. That Russian exposure comprised 5.5% of SFDR Article 8 funds and, curiously, an even higher percentage (about 9%) of SFDR Article 9 funds. Moreover, that was a conservative estimate.
To make the volume of data more manageable for the purposes of this research, the large Article 8 fund universe was narrowed down to the 10 largest European providers, as ranked by IPE: BlackRock, Legal & General Investment Management, BNY Mellon Investment Management, Insight Investment, Natixis Investment Managers, Goldman Sachs Asset Management, State Street Global Advisors (now State Street Investment Management), Schroders and DWS.
This total aggregate Russian exposure peaked at about €5bn at the end of 2021, before collapsing during February 2022. That sharp fall in itself suggests that the SFDR minimum safeguards mechanisms failed to work during the many months when world governments openly and vocally expressed their concerns about the possibility of the first large-scale invasion in Europe since the Second World War.
For example, after US president Joe Biden’s warning during his call to Vladimir Putin in early December 2021, sustainable funds actually added to their Russian holdings by the end of the month. In other words, they seemed to have treated looming war as a valuation opportunity rather than a sustainability alarm.
So, what are these Russian assets that were considered sustainable by our leading asset managers? It was a small group of issuers, closely linked to the Kremlin. The sample of 391 funds invested in 34 entities, 23 of which were sanctioned by the US and EU after the invasion. However, the holdings seem they should have been totally out of line with SFDR definitions and were also difficult to reconcile with Taxonomy Regulation minimum safeguard requirements, which are also linked with the SFDR Do no significant harm principle. This is because of their role as direct enablers of Moscow’s war economy and oppression.
For example, steelmaker NLMK has been a key supplier to the Russian manufacturers of missile systems, tanks and even nuclear weapons. Much of this information had been in the public domain. Alrosa, the world’s largest diamond producer, partly owned by the Russian government, had sponsored the Russian navy since the late 1990s. VTB Bank arranged deals with diplomatic strings attached, facilitating Russian arms sales abroad, and was subsequently accused by the US authorities of funding covert political interference operations by the GRU (Russian military intelligence) in the run-up to the 2016 presidential elections.
Since the Russian invasion of Georgia in 2008, the ICT platform Yandex has become a tool of censorship and disinformation; this search engine has lately been suppressing coverage of atrocities such as Bucha. PIK Group, backed by politically connected oligarchs, provided organisational assistance to the Ministry of Defence in their military recruitment drive for the invasion.
Other core entities supported and financed the Kremlin’s aggressive geopolitical ambitions. For example, Gazprom and Novatek underpinned state revenues, while using coercive diplomacy through energy and corruption. PhosAgro channelled wealth to Kremlin-linked elites.
Hard legal safeguards needed
The findings underscore the need for reform that would introduce hard legal safeguards to prevent sustainable investments helping autocrats equip their illegal wars and oppression. However, the European Commission seems to be in no hurry, with the much-needed overhaul of the SFDR “reprioritised” to at least until 2027. That leaves investors operating within a failed regime, which is unlikely to offer better guidance for more ambiguous authoritarian-risk exposures than in the clear-cut Russian case examined here.
However, it takes two to tango, and existing rules leave plenty of opportunity for providers to take responsibility themselves. The key question here is where do we draw the line in what is regarded as sustainable? Indeed, it is one at the centre of my current project to develop an investment research model that would filter out emerging market entities carrying unacceptable risks for democratic security. Whilst this academic work continues to be self-funded, I do believe there are pension funds and asset managers out there, for whom sustainability means more than just a sales pitch.
Sergei Cristo is a former BBC journalist, a political activist and a specialist in media communications, asset management and sustainable investment
