Stockholm (NordSIP) – In its Report on Trends, Risks and Vulnerabilities, the European Securities Market Authority (ESMA) acknowledges that ESG indexes have outperformed their traditional benchmark. However, the report notes that the same success has not been shared with sustainable fixed income markets and that many challenges remain.
“In the equity markets, over the past two years, the ESG Leaders 50 index has outperformed the corresponding benchmark index,” the report argues. “This supports the view that investing in ESG does not compromise returns for sustainability, but instead enhances returns within a process of better-incorporating ESG factors. This also holds when considering volatility: risk-adjusted returns of ESG indices have consistently outperformed the corresponding main index benchmark (the Euro Stoxx 50) in recent years.”
Green Bonds Disappoint
The European regulator is much less optimistic about the performance of green bonds. Citing research by the IMF, ESMA states that “there is no significant evidence yet that points to outperformance or underperformance of green bonds relative to conventional bonds.”
Challenges: Greenwashing and Short-Termism
The report goes on to note that ESG integration faces several hurdles. ESMA cites well-known issues such as “the lack of certainty on the definition of sustainable activity, the lack of reporting standards and, as a result, a lack of comparability, reliability and timeliness”. The security and markets authority holds hope that the forthcoming EU taxonomy will” improve the clarity on the criteria an economic activity must meet to qualify as positively contributing to EU sustainability objectives”.
According to the European financial regulator, the danger with the present state lack of clarity is that it creates room for abuses and misrepresentation. “The lack of standardisation can lead to greenwashing, 30 reputational risks and uncertainty in measuring ESG impacts.” In issuing this warning, ESMA once again echoes the IMF’s concerns, which noted that “false claims of ESG compliance of assets and funds, so-called greenwashing, may give rise to reputational risk. Investment fund classifications can be inconsistent. For example, only 37 per cent of Lipper ethical funds also carry a “sustainable” designation by Bloomberg.”
Lastly, ESMA’s report also highlights the dangers and drivers of short-termism. “While asset managers typically have a short-term horizon (1 year or less) in their asset evaluations and incentives, investors and asset owners may have much longer-term horizons.” According to a survey of market participants conducted by ESMA, short-termism is driven by client demands, sell-side analysts, market and competitive pressures. Survey respondents noted that ESG disclosures provided insights into companies’ long-term risk profile, complementing information in financial statements and providing insights into companies’ future financial performance.