Enabling investors to participate in a sustainable economyBy Michael Collins on 2 November 2017
The European Union is calling on the financial sector to support the shift to a sustainable economy. European private equity and infrastructure funds have access to global investment capital, but they need clarity and long term certainty to play their important role.
The European Union is calling on the financial sector to support the shift to a low-carbon, resource-efficient and sustainable economy. European private equity and infrastructure funds have access to global investment capital, but they need clarity and long term certainty to play their important role in creating a sustainable finance system.
Policymakers recognise that urgent investment is needed to upgrade the infrastructure that European citizens rely on for transport, power, healthcare and other services. They also see that millions of businesses – from small and medium-sized enterprises to larger corporations – benefit from private capital and expertise to boost economic growth and job creation. The European Commission wants this new investment to be oriented towards long term, sustainable projects and away from those with short horizons. The Commission estimates that €180 billion of investment per year is needed to make the switch and to deliver on the climate and energy targets enshrined in the Paris Climate Agreement and the UN’s Sustainable Development Goals for 2030.
Investors have ample capital to meet the challenge – according to the European Fund and Asset Management Association (EFAMA) total European assets under management hit €22.8 trillion in 2016, with institutional investors such as pension funds and insurers comprising 73% of the total. Moreover, sustainability issues are high on these investors’ agendas, as they respond to savers’ demands for more ethical standards and it becomes increasingly clear that responsible practices also make for good investments. For them, private equity and infrastructure funds provide a critical connection for long-term investments and returns. However, there are obstacles that must be addressed if we are to release the full weight of investor resources into sustainable investments.
Late last year, as part of its Capital Markets Union action plan, the European Commission formed a High-Level Expert Group (HLEG) on Sustainable Finance, to look at the role of the financial sector in sustainable products, such as so-called “green” bonds, and investments with strong environmental, social and governance (ESG) standards. The comprehensive interim report published in July made suggestions for removing some of the impediments. For instance, it outlined the need for a clear classification system for sustainable assets, recommended strengthening ESG reporting requirements, and proposed creating a dedicated organisation to match investors with relevant projects in different countries.
Invest Europe welcomes the interim report and recognises the achievement in producing such a wide-ranging piece of work in a short space of time. There are still important issues that must be tackled in the final report which we believe would facilitate greater investment by our members into sustainable projects and businesses.
While access to deal-flow is not a problem for many private equity and infrastructure investors, stability and certainty in domestic policy can be. We witnessed a stark example five years ago when, following significant investment into Spain’s renewable energy sector, the government announced three major retroactive changes to renewable energy contracts. As a result, the economic case for millions of euros of investment into valuable ecological projects was undermined. Infrastructure assets have long lifespans stretching into decades, so investors need a stable and predictable regulatory environment in order to deliver returns to their investors. The Spanish government’s short-termist action effectively deterred fund managers from making further investments in the country.
Pricing is another important factor for the industry. Currently an asset’s market price does not reflect its environmental and social impact because the tax, regulatory and other policies that internalise such costs are not in place. The HLEG’s report suggests adjusting existing regulation – such as Solvency II or the Alternative Investment Fund Managers Directive – to encourage greater investment, but this alone will not tackle the problem. We need a “whole economy” approach that goes well beyond emissions trading and carbon tax initiatives. If policy can get pricing right, then combined with the analytical skills and experience of private equity and infrastructure fund managers, we can ensure that capital flows into investments that will propel Europe towards a more sustainable economy.
The HLEG is collecting feedback and will deliver its final report by the end of 2017. We hope the report will mark the beginning of the debate and not the end. Certainly, for Invest Europe members – which range from large insurers and private equity groups to small venture capital firms – sustainability is an increasingly important consideration. To that end, our association is organising events such as Invest Week (20-24 November in Brussels) and providing guidance and tools to enable members to integrate ESG into their day-to-day operations.
But that on its own is not enough. Fund managers and investors require long term certainty with regards to regulation, and need to see underlying prices for assets that incorporate ESG considerations. For that, we need a joined-up policy response at European and global level. Only then will Europe be able to create a true sustainable finance industry and meet its long term climate and responsible investment goals.