An equity portfolio built on sustainability criteria shows a misalignment with the EU Taxonomy, according to a study conducted by German fund industry association BVI.
The reason for the result lies in the narrow scope of the EU Taxonomy, the study said.
For example, in terms of climate change mitigation, which is one of the six objectives of the EU Taxonomy, “green revenues” as defined by the Taxonomy apply only to four sectors including industrials, materials, utilities and real estate.
Therefore, the study concluded, the EU taxonomy alone is not a measure to define the sustainability impact of an investment portfolio. It addresses only the climate side, but not the social aspect of sustainability, it added.
Moreover, the Taxonomy covers so far only climate risk mitigation and adaptation, two out of six environmental objectives, and only about one-third of macroeconomic sectors, BVI added.
BVI built a portfolio based on Article 8 of the Sustainable Finance Disclosure Regulation (SFDR), which refers to financial products promoting environmental or social characteristics, the FTSE World index, best-in-class, minimum exclusion criteria and ‘value’ investing.
The FTSE World Total Return Index covers 90- 95% of the investable global market capitalization and 2,494 companies, it said. The portfolio resulting from applying sustainability standards includes 473 companies.
The use of minimum exclusion criteria leads to pull out 4.3% of the index weight, or 85 companies out of 2,494. It leads to a reduction of 2% of the average ESG risk scores, the study said.
The best in class approach cuts the investable universe to 1,011 securities from 993 companies, representing a reduction of 59% of the number of issuers, it added, while the average ESG risk score is reduced by 13%.
The value investing approach leads to investing in up to 475 stocks issued by 473 companies active in 103 industries and 26 countries, which represent a 52% reduction in the total basket of firms.
The study noted that using minimum exclusion criteria, together with best in class and value approaches, results in an ESG risk score that is 19% lower than that of the market index.
BVI stressed that a further development of technical criteria is necessary to improve the alignment of funds’ portfolios to the Taxonomy.
BVI expects an increase in regulatory efforts to design technical screening criteria for the remaining environmental objectives of the Taxonomy and the inclusion of social aspects. These developments are expected to come into effect starting in 2023, it said.
The fund industry association recently criticised the German financial authority, BaFin, for its proposal of guidelines on sustainable investing.
According to reports, BaFin plans stricter rules on sustainable investments by issuing new guidelines for mutual funds.
Based on the guidelines, which are not yet published, a fund can be categorised as sustainable if invests at least 90% of its assets sustainably and pursues a sustainable investment strategy, said BVI’s chief executive officer Thomas Richter in a note.
BaFin wants to prevent green washing through the new set of rules, but in fact it would “catapult Germany out of the competition as a location for sustainable funds,” Richter said.