How can the finance industry reach net-zero? Is the EU Taxonomy a real lever to shift money in the right direction? We asked some questions to Prof. Dr. Alexander Bassen, Professor of Capital Markets and Management at the University of Hamburg and Member of the German Advisory Council on Global Change.
Prof. Dr. Alexander Bassen
For almost 20 years, Prof. Dr. Alexander Bassen has been engaged in the development of sustainable finance, namely with experiences such as his presence as Member of the German Council for Sustainable Development (RNE) or his current involvement at the Federal Ministry for the Environment, Nature Conservation, Nuclear Safety and Consumer Protection within the German Advisory Council on Global Change. As Tomorrow keeps on investigating which levers can maximize positive impact in the finance sector, we thought that an exchange with Professor Bassen would bring some new light on the topic - for us as well as for our community. We asked him 5 important questions on how to establish sustainable finance at the heart of society.
Tomorrow: To build a sustainable and resilient system, we need to transition successfully to a more sustainable financial system. In your opinion, what can the finance industry do to help society and the economy reach net-zero?
Alexander Bassen: In our report of the German finance council (Sustainable-Finance-Beirat) called “Shifting the trillions”, we propose some important solutions to the allocation of capital towards ESG (Environmental, social, governance) assets. The global challenges we have to address are currently mostly negotiated by governments. If we look at the needs emerging countries have and the establishment of funds such as the Green Climate Fund, the needs for better healthcare systems or changing infrastructures to deliver green energy, affordable and sustainable housing etc.; it is basically impossible for public actors right now to finance the change we need with public investments. To get a chance to achieve net-zero, we need to change the behavior of companies and activate private investors to meet the targets set by the Paris Agreement.
Tomorrow: It can sometimes be frustrating that most of the investments offered today are focused on avoiding harm to the environment and society, but it seems very difficult to identify opportunities that do create real additional impact. What are the most powerful levers in your eyes to create additional impact with investments?
Alexander Bassen: I used to be a member of the G7 Impact Taskforce* and I saw there that terminology matters. The term of impact has been used for more than 20 years. To make the effect usable for investments, we differentiate between impact-aligned and impact-generating investments. Equity investments are usually impact-aligned, for example we created an SDG-aligned (Sustainability Development Goals) index for the United Nations and used the term impact-alignment because this describes best what the index does: it does not create additional value, but it is aligned with certain objectives. An impact-generating investment is something else: it is combined with additionality, but with simple “stock picking” it is very difficult to achieve additionality. What can matter and where everyone has a chance to play a role is with engagement. Engagement as a shareholder or group of shareholders defines companies’ agendas, brings hidden topics to the front and is a chance to make real change happen. Divestment can also be effective. It is basically choosing not to support companies or projects that you do not agree with and are probably harmful for the environment and society or do not show good governance practices. Bonds are quite different, as you can also generate impact with the investment itself, particularly at issuance.
Tomorrow: Can you share a bit your perspective on the EU Taxonomy and its recent developments?
Alexander Bassen: The taxonomy is an important step to implement the 6 defined environmental objectives:
climate change mitigation
climate change adaptation
sustainable use and protection of water and marine resources
transition to a circular economy
pollution prevention and control
protection and restoration of biodiversity.
All of that while respecting the principle of “do no significant harm”. The taxonomy is based on performance, it has very clear thresholds for CAPEX, OPEX (Capital expenditure and operating expense) and revenues, but also focuses on non-financial disclosures. Many companies that are eligible for the taxonomy also have to start reporting on social and environmental aspects with the CSRD**. Long story short, the new reporting obligations and the European framework are a good way to align company reporting and investor reporting. It should also bring clarity on what is classified as “sustainable activity” and to what degree this activity is considered sustainable within its own category. The taxonomy is a good step in the right direction. However, there are also a lot of problems associated with it at the moment. For example, investors already had to report on the PAIs (Principle Adverse Impact) of their investments before the companies even reported on them. Now the EU is aware of these challenges; they started with 2 objectives in the beginning (climate change adaptation and mitigation), and they will now have to introduce the remaining four objectives promptly.
Tomorrow: It seems that there are different ways of understanding the EU taxonomy: for some, it is a way to show the most sustainable companies also within controversial sectors; for others, the taxonomy should focus on showing the most sustainable industries and exclude controversial sectors, which is also Tomorrow’s standpoint. What is your view on the addition of controversial sectors in the amendments of the EU Taxonomy?
Alexander Bassen: If you talk about nuclear and gas, the arguments for including them were mostly that we cannot transform society without transforming and relying on those sectors. Some also claim it was purely a political decision, which would be a shame, since the Platform on Sustainable Finance worked hard on bringing to life the taxonomy on a voluntary basis: it would be disappointing if a political decision destroyed the work the Platform has done so far. In my opinion, controversial sectors should not be covered by the taxonomy because it sends the wrong signal to all stakeholders.
Tomorrow: Have you already seen market signs that the EU Taxonomy is helping investors making more informed decisions when it comes to sustainability?
Alexander Bassen: I am not sure if it is helping investors per se, but it influences their decisions. The pressure from asset owners (whose money is invested) on asset managers (who allocate the asset owners’ capital) is increasing, as asset owners do not want to see sustainability risk on their portfolio or on the asset manager itself. When you see cases such as the Deutsche Bank’s DWS being sued over fund greenwashing allegations in October 2022, even if we still have to wait for the lawsuit outcome, it shows that there is a general movement to look deeper at “sustainable investments”, how they are defined, how they are reported on. Asset owners will not want to keep playing with these risks.
Tomorrw: In 2020, the EU Commission published the SFDR (Sustainable Finance Disclosure Regulation), requiring financial players to label their products either as Article 9 (dark green), Article 8 (light green) or Article 6 based on their sustainability ambition.
The Tomorrow Better Future Stocks fund, available via the Tomorrow app, was launched in October 2022 and is labeled Article 9, investing only in truly sustainable companies. How do you see the difference between those labels?
Alexander Bassen: Article 9 funds should make a contribution to social and/or environmental objectives, whereas Article 8 funds promote some environmental or social characteristics. The EU Commission is also aware that there are still misconceptions on the use of those categories, and is currently working on creating a more precise differentiation between what Article 9 and Article 8 means.
Article 9 funds also have to state which proportion of their investee companies are aligned with the taxonomy. Since this year is the first year of reporting within that framework, it will be interesting to see what companies report on their taxonomy-alignment. We are doing an analysis this year with a partner, which will give us a lot of insights on how companies report on their taxonomy-alignment for the first time.
Learn more about the article 9 Fond - the Tomorrow Better Future Stock - and invest in your future.
*An initiative established under the United Kingdom’s G7 presidency in 2021, intended to direct global investments towards sustainable transition
**CSRD (Corporate Sustainability Reporting Directive) is a mandatory reporting requirement for large and listed European companies to report on sustainability risks and opportunities, with the first reports to be published in 2025