Europe has racked up a multitude of labels aimed at certifying and promoting sustainable & responsible investment. Meanwhile, ESG ratings based on a quantitative approach have started being developed. It's time to figure out just what's what!
The commitment to meeting environmental, social and governance (ESG) criteria has taken off in recent years. Between 2012 and 2014, this growing interest for responsible finance triggered a 61% rise in AuM incorporating ESG criteria to $21,358 billion (at end-2014) according to the Global Sustainable Investment Review. This passion has particularly swept across Europe, which holds nearly two-thirds of the global market in addition to a wide range of Sustainable & Responsible Investment (SRI) labels.
SRI labels made their debut in Europe over 20 years ago, in the wake of the first sustainable investment funds. While the Eurosif Transparency Codes provide a detailed explanation of how ESG indicators are used to manage a fund, and are prerequisites to obtaining recognition of a fund's SRI status in France or Belgium, SRI labels are used to review and assess the consistency, sincerity and reliability of aspiring funds. Their purpose is to promote and especially to certify SRI in order to reassure individual and institutional investors about the nature of the funds in which they are investing.
In recent years, more and more of these labels have been developed in Europe and adopt a wide variety of approaches. Most SRI or ESG labels take a general approach, but may also be associated with a given theme such as the energy transition, the environment, social issues, solidarity, micro-finance, etc. While such labels are predominantly the result of private initiatives (e.g. European Luxflag labels launched in 2010), the growing interest expressed by government authorities in promoting SRI is driving them to create national labels. This is the case in France, for example. After the Novethic label was created in 2009, the national SRI label was launched in 2016. Another example is Germany's FNG label, which was also adopted by Switzerland and Austria.
As the number of labels increases, however, it is not always easy for individual or institutional investors to make heads or tails of what's out there, especially since these labels do not adopt the same approach or selection/exclusion criteria. The Austrian eco-label, created in 1990 under the aegis of the Ministry of Agriculture and the Environment, is unique in that it rates companies, environmental investment funds and, more surprisingly, everyday consumer products. The eligibility criteria for the French national label take into account other specific factors such as an issuer's ESG analysis methodology, commitment policy (voting and dialogue) and transparency. The selection criteria also include the limited use of derivatives in building portfolios, as well as the highlighting of positive impacts on the development of a sustainable economy.
Alongside the development of qualitative SRI labels, a quantitative approach has emerged in recent years, with ESG ratings by fund, just as there are ratings on an investment fund's performance quality. This approach uses the ratings provided by specialist analysis agencies such as Vigéo, EthiFinance, INrate and Oekom, aimed at measuring the ESG performance of companies, governments and public institutions, primarily for institutional investors and financial data providers. By weighting these ratings in each line of an investment fund's portfolio, we can extrapolate an average rating that reflects the portfolio's ESG quality. In conjunction with analysis agency ESG Sustainalytics, Morningstar created the Morningstar Sustainability Rating in March, covering 20,000 funds (equities and corporate bonds). The same effort led to the creation of the MSCI ESG Fund Quality Score, ultimately expected to cover 21,000 funds and ETFs.
There is no shortage of initiatives aimed at governing SRI best practices, which should continue to expand as demand grows further. In this environment, investors (especially individuals) will have an embarrassment of riches when it comes to choosing the right SRI label or ESG rating to meet their objectives, constraints and view of SRI.