Label vs. Logic

Not-so Green Day. TNFD sneak peek. Sustainable aviation pressures. Plus, MSCI moves the market.

In the world

🇺🇸 The GOP’s anti-ESG crusade is stumbling in the face of asset manager and regulator pushback, reports Bloomberg. Though US companies face 60% more anti-ESG proposals this year relative to 2022, legislators have indicated that decisions about sustainable finance are, perhaps, best left to capital markets rather than courts. 

🇬🇧 Pitched as an answer to US climate action, the UK’s hotly anticipated ‘Green Day’ — sorry, ‘Energy Security Day’ — has proved something of a disappointment. There were, however, measures of note in the government’s new Green Finance Strategy, including a timely consultation on ESG ratings, tailwinds for carbon capture, and a possible carbon tax.

🗺️ The Taskforce on Nature-related Financial Disclosures (TNFD) has released its fourth and final beta framework, with an emphasis on sector “comparability and flexibility.” Included among its proposals is a tiered approach to metrics and a ‘Scopes’ approach akin to that used for climate reporting. For the first time, TNFD made available the full framework. 

🗺️ It’s been a big week for standards. The World Federation of Exchanges unveiled the world’s first framework for green equities — the Green Equity Principles — which includes a (notable, in our view) clause for revenues. Yesterday, the Integrity Council for the Voluntary Carbon Market published its long-awaited benchmark for carbon credits, the Core Carbon Principles.

🇪🇺 It’s been a big week, too, for sustainable aviation fuel (SAF) in the EU and UK. Claiming the US had “thrown down the gauntlet” with its Inflation Reduction Act, airline executives urged the EU to implement incentives for “a world-leading SAF industry.” European companies — including, this week, Repsol and Lufthansa — are racing to keep up with US investment. 

🇪🇺 Helmed by NGO ShareAction, a group of investment groups representing a collective $4T are turning the screw on the high-emitting chemicals industry. In a joint statement, the coalition called on Europe’s 13 largest chemical companies to live up to their net-zero commitments and forge a path away from fossil fuels. (The World Economic Forum also has ideas.)

🇪🇺 The EU’s (newly strengthened) ‘Fit for 55’ decarbonisation package — which includes a suite of measures aimed at keeping it track to reduce emissions 55% by 2030 — will “kickstart a wave of climate litigation” against “government action or inaction,” according to a new report by the Grantham Research Institute on Climate Change and the Environment.

In the spotlight: Labels vs. Logic

It may not be as dramatic and du jour as some, but it’s a seminal sustainable finance story.

Last week, the Financial Times revealed that index and ratings provider MSCI is set to strip hundreds of funds of their ESG ratings and downgrade thousands more. Per an unpublished note obtained from MSCI client BlackRock, the shake up comes as a result of planned methodology changes.

It’s hard to overstate the impact of those changes. They apply to all funds benchmarked against MSCI indices, which represent a staggering $13.5T. Up to 31,000 funds face downgrades globally. The impact will be most keenly felt in Europe. 

ESG compliance is, by now, virtually a prerequisite for European institutional flows. The number of European ETFs with a triple-A ESG rating will fall from 1,120 to just 54, while those with no rating will surge from 24 to 462. Overall, almost two thirds of the European ETF market will be rated lower or removed from MSCI’s ESG universe. 

That doesn’t leave many left. 

To make matters worse, there’s a dwindling number of Article 9 funds in which to take solace. Following the recent wave of downgrades, the EU introduced new rules to clear up confusion. Those have, however, resulted in “investor uproar,” with asset managers calling the new criteria “unworkable.” Tense discussions between investors and regulators may result in the entire category being binned, reports the Financial Times

Justifying its tweaks, MSCI told Bloomberg that it now believes the threshold required to receive an AA or AAA rating  “should be more rigorous and ambitious.” 

About time.

In two (different) reports in the last two years, Util has called into question the threshold of ESG-branded funds. 

  1. In 2021, we measured the social and environmental performance of ESG versus non ESG funds.
  2. In 2022, we assessed the best- and worst-contributing funds relative to each of the SDGs.

In neither of those reports did we conclude that ESG funds should be stellar performers relative to the Sustainable Development Goals, but we did question some of their more grandiose marketing claims. Those are owed, in no small part, to MSCI. As we explained in an issue of this newsletter (‘MSC-why’) back in 2021: 

The chasm between perception and reality, marketing and methodology, is something out of which asset managers and ratings providers have made an enormous amount of money. Particularly MSCI.

And that really is an issue, because it doesn’t just deliver data; it also builds and weights indexes. A lot of them. Bloomberg finds 60% of all retail money ploughed into sustainable or ESG funds globally has gone into those built on MSCI’s ratings.

So: The myth (that ESG investing creates positive impact) attracts money (earmarked for ‘good’), which MSCI allocates to companies (who, like McDonalds, may be very good at installing recycling bins to appease regulators but very bad at bringing its emissions down to the level of, like, one, rather than two, countries). 

Now think about that at scale. If the two biggest financial trends of our time are passives and ESG, and MSCI has a monopoly on both, any failings in the latter are amplified by the former. 

Though this latest development is related more to its fund than company rating methodology, the point stands: it’s really, really risky to be gambling on ESG ratings when so many funds and so much money is riding on the outcome.

ESG Clarity writes that the downgrades put the onus on asset management firms to ‘take control of evaluation’. For sustainable fund providers, this latest development provides more — and not less — reason to rely on logic over oversimplified labels. It might require more work, but the reward is an ever-growing pool of client capital looking for a sustainable home with — for the moment — nowhere to go.

In the news

🗞️ ESG funds are bracing for mass downgrades on the back of MSCI’s (recently announced) ratings overhaul. Speaking with Bloomberg Law, Util CEO Patrick Wood Uribe explores the broader implications for the sustainability data and funds markets.

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