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FinReg > Sustainable finance 1 & 2 > Flashcards

Sustainable finance 1 & 2 Flashcards

1
Q

What field study was done?

A

a field study in cooperation with a Dutch pension fund, that invests on behalf of its members. Higher contribution fees are paid when the fund doesn’t meet its performance targets. Participants faced the choice of whether they wanted to increase the investment focus on the UNs’ Sustainable Development Goals (SDGs) through engaging with companies that underperformed on the selected SDGs. The authors informed participants that implementing SDGs means financial returns are not the only factor to take into consideration.

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2
Q

4 criteria for the field study

A
  1. Participants should care about the outcomes
  2. The authority can enforce payment by voters
  3. The elicitation involves a yes or no vote on a single project
  4. The prob that the proposed project Is implemented is weakly monotonically increasing with the proportion of yes vote.
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3
Q

Study was conducted in

A

2 Surveys in 2018 and 2020

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4
Q

Findings of 1st study

A
  1. 2/3 of participants favor increasing the pension fund’s engagement to increase the sustainability of the companies in which it invests and choose 4 SDGs.
  2. Only 10.8% are against the increase and chose 3 SDGs,
  3. 21.2% has no opinion.
  4. The results from a nonconsequential question show 74.4% of respondents also favor portfolio screening based on the four SDGs.
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5
Q

Authors explore three possibilities that drive strong support for more sustainable investments:

A
  1. Participants might have expected sustainable investments to financially outperform conventional investments.
  2. Participants could have strong social preferences in favor of sustainable investments, in which case they support sustainable investments even when these investments are financially costly.
  3. Subjects might not have taken their real choice seriously or they could have simply been confused.
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6
Q

Second study

A

Authors let the participants know how the pension fund improved. The results show that time, the actual implementation, or the differentiation between engagement and portfolio screening do not let the strong support for sustainable investing crumble. Moreover, the support for extra sustainable investments has remained strong during the global COVID-19 pandemic. This finding highlights that participants still favor more sustainable investments when they see how the pension fund implemented its commitment.

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7
Q

Support for sustainable investments is

A

Pro-cyclical. In other words, people support sustainable investing as long as they are doing well themselves. During the second study, the COVID-19 pandemic had caused a period of significant economic downturn, putting Dutch pension funds’ balance sheets under pressure.

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8
Q

This belief distribution shows participants see the economic impact of the COVID-19 pandemic as

A

more than a minor, temporary economic recession. Strikingly, the support for portfolio screening is independent of the beliefs about the influence of the corona crisis for pension benefits. Even among the group that expects the COVID-19 crisis to considerably lower their retirement benefits, 61.8% support portfolio screening. This finding shows sustainable investing has significant support even during times of economic hardship

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9
Q

Results 2nd study

A
  • The majority of participants support extra engagement and portfolio screening, even if they believe the retirement benefits will be a bit lower.
  • The support is much lower for those participants who expect engagement and screening to significantly lower their pension benefits.
  • Women are more likely than men to support sustainable investments.
  • Higher-income individuals are less likely than lower-income individuals to support engagement or screening.
  • Social signaling can play a significant role when deciding whether to invest sustainably. It is the notion that people prefer to be seen as prosocial individuals.
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10
Q

Conclusions

A

Most participants believe a greater focus on sustainability does not come at the expense of financial returns, or are at least uncertain about whether it does. But even among those who do expect a reduction in financial returns, the majority wants to put their pension money on the table to promote sustainability. A key reason is participants’ strong social preferences.

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11
Q

EU commission defines sustainable finance as

A

the process of taking environmental, social, and governance (ESG) considerations into account when making investment decisions in the fin sector, leading to more long-term investments in sustainable economic activities and projects

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12
Q

How does sustainable investment work?

A
  1. ESG Integration
  2. Exclusionary investing
  3. Inclusionary investing
  4. Impact Investment
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13
Q

EU commission regulation

A

atm no regulation, only proposal that pension funds ask clients how they wish investments to be made

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14
Q

What could regulators do?

A
  1. Make sustainable investment mandatory
  2. Set high standards
  3. Rely on industry self-control
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15
Q

2 narratives that show the link between environmental sustainability and fin reg

A
  1. Financial institutions as facilitators of the greening of the economy - Ensuring that econ activity to which funds are available are aligned with EU’s env policy
  2. Financial institutions are themselves subject to risks that are generated by climate change - climate change has an impact on the stability of fin institution
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16
Q

Environmental sustainability

A

includes all man-made
environmental risks (not only climate risks) identified
by some scientists as the nine planetary boundaries

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17
Q

Carbon intensive activities lead to

A

global warming,
rising sea levels and ocean acidification (longer term
effect) and volatile weather patterns, intensified
flooding etc. (more immediate effects)

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18
Q

There are linkages between the environment and

A

financial stability (e.g., Hurricane Katrina)

19
Q

UN 2030 Agenda for Sustainable Development (2015)

A

Sustainable Development Goals (SDGs) cover three pillars of sustainability: environmental,
social and economic/governance (ESG)

20
Q

Paris Agreement on Climate Change (2015)

A

• Limit global warming to well below 2°C and purse efforts to limit it to 1.5°C above pre-industrial levels, acknowledging that this would reduce the risks and impacts of climate
change
• Acknowledgement that the financial sector has a central role to play in enabling the
transition to an environmentally sustainable economy in line with these climate targets
(‘finance for transition’)

21
Q

Environmental considerations:

A

might include climate change mitigation and adaptation as
well as the environment more broadly, for instance the preservation of biodiversity, the
prevention of pollution and the circular economy

22
Q

Social considerations:

A

could refer to issues of inequality, inclusiveness, labor relations,
investment in human capital and communities as well as human rights issues

23
Q

Governance considerations

A

typically include management structures, employee relations

and executive remuneration.

24
Q

Risk of “greenwashing”

A

• Limited disclosure of carbon footprint (let alone other ESG factors) by non-financial and financial
firms.
• There is still a lack of common understanding as to the precise contribution an investment must
make with a view to ESG factors to qualify as sustainable.
 It is difficult for investors to verify whether an investment is truly sustainable

25
Q

Climate change as source of fin risk:

Sources of risk => transmission channels =>Financial risks

A

Sources:

1) Physical: directly linked to climate change
2) Transition: not directly linked to climate change

Transmission channels:

1) Impacts on sovereigns
2) Impacts on corporations
3) Impacts on households
4) Macro: lower growth and productivity

Fin risks:

1) Credit
2) Market
3) Liquidity
4) Operational
5) Underwriting losses

26
Q

Green swan events

A

Potentially extremely financially
disruptive events that could be behind
the next systemic financial crisis

27
Q

Market failures and impediments in reducing exposure to risks

A
  1. Serious over and underestimation of risks (mispricing of risks)
  2. Asymmetric information (substantial data gaps)
  3. Financial stability is a public good
  4. “Tragedy of the Horizons” (Mark Carney):
     The current generation has no incentive to act since the disastrous impacts of climate
    change will be felt beyond the tradition horizons of many stakeholders: business cycle,
    political cycle and cycle of technocratic authorities.
     Mismatch between the need for policy measures in the short term to mitigate the impacts of
    climate change on financial stability in the long term.
28
Q

The role of the banking sector: Banks are key

A

facilitators of the transition to a low-carbon economy
 Mobilizing and reallocating capital away from unsustainable economic activity to
more sustainable sectors of the economy  channeling funds into “green”
investments and sectors

29
Q

The role of the banking sector: Banks are themselves exposed to

A

significant financial risks caused by climate
change and climate change mitigation policies
 Building financial resilience to environmental risks
 Recognizing risks and incorporating sustainability factors into risk management
models and governance frameworks

30
Q

The role of central banks: Activist approach

A

Active support by Central Banks is needed to
reach Paris climate goals.
Central Banks’ monetary policy instruments
are currently exacerbating climate change.
These instruments should, in fact,
incorporate environmental sustainability
criteria.

31
Q

The role of central banks: Passive approach

A

Maintaining stable nominal prices is the best a
Central Bank can do to support the low-carbon
transition.
Central Banks must clearly separate themselves
from politics (Central Bank independence).
Central Banks must take a neutral stance
towards markets (‘market neutrality’).

32
Q

Commission Sustainable Finance Action Plan (2018)

A
  1. Redirecting capital flows towards a more sustainable economy
  2. Mainstreaming sustainability in risk management
  3. Foster transparency and long-termism
33
Q

Commission Sustainable Finance Action Plan (2018)

1. Redirecting capital flows towards a more sustainable economy

A
  • Classification of sustainable activities (Taxonomy Regulation)
  • Standards and labels for green financial products (e.g., Green Bond Standard)
  • Incorporating sustainability when providing financial advice (e.g., revision of MiFID II)
  • Developing sustainability benchmarks (Benchmark Regulation)
34
Q

Commission Sustainable Finance Action Plan (2018)

A

Clarifying institutional investors’ and asset managers’ duties (e.g., Disclosure Regulation)
• Integration of sustainability in ratings, and in prudential requirements of banks and insurance companies

35
Q

Commission Sustainable Finance Action Plan (2018)

A
  • Strengthening sustainability disclosure and accounting rule-making (review of the Non-financial Reporting Directive, NFRD)
  • Enhancing corporate governance and tackling short-termism in capital markets.
36
Q

Enhanced EU sustainable finance strategy (2021)

A
  1. Financing the transition of the real economy towards sustainability
  2. A more inclusive sustainable finance framework
  3. Improving the financial sector’s resilience and contribution to sustainability: the double
    materiality perspective
  4. Fostering global ambition
37
Q

Three main areas of regulatory action

A
  1. Create an EU classification system of what is a ‘green’ / ‘brown’ investment
  2. Make sustainability transparent through disclosure
  3. Prudential treatment of sustainability risks
38
Q

The Taxonomy Regulation – A EU classification system

A

• Purpose: Establishes uniform criteria for determining whether an economic activity is
environmentally sustainable and whether and to what extent an investment is environmentally
sustainable (Article 1(1))
• Scope: Criteria apply when
• the EU or a Member State sets out requirements on market actors in respect of financial
products that are marketed as environmentally sustainable; or
• financial market participants offer financial products as environmentally sustainable
investments

39
Q

The Taxonomy Regulation – A EU classification system:

Economic activities are considered green when

A
  1. Significant contribution to at least one environmental
    objective
  2. No significant harm to any of the other environmental
    objectives
  3. Compliance with certain social minimum safeguards
40
Q

The Taxonomy Regulation – A EU classification system:

Sustainable “dark green” activities

A

Activity in and of itself
produces very small or no
GHG emissions
Example: forestation

41
Q

The Taxonomy Regulation – A EU classification system:

Enabling activities

A 
Activity directly enables other 
activities to contribute to the 
environmental objectives
Example: manufacture of 
windmills
42
Q

The Taxonomy Regulation – A EU classification system:

Transition activities

A 
Activity supports the transition 
to a climate-neutral economy 
and there is no feasible low carbon alternative
Example: production of 
cement and steel
43
Q

Disclosure: Sustainable Finance Disclosure Regulation

Aim

A

Harmonized rules for financial market participants and financial advisers on
transparency with regard to (1) the integration of sustainability risks and (b) the consideration of adverse
sustainability impacts  making sustainability and its risks transparent

44
Q

Disclosure: Sustainable Finance Disclosure Regulation

Scope of the Regulation:

A

 Covers a large group of financial market participants and products: AIFM, UCITS management
companies, Insurance companies, pension product providers, etc. and their associated products.
 Disclosure required for two types of information: disclosure at the level of the financial market
participant or financial advisor AND product specific disclosure.

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