Retail investors are unlikely to select funds based on the proposed EU Ecolabel, if its green impact is not clearly communicated, critics say.
Julia Dreblow, founder of SRI Services & Fund EcoMarket, told Expert Investor that a draft document on the EU Ecolabel is “on the right track”, and “appears to signal a desire to lead rather than follow the debate”.
However, she pointed out that how to communicate the label to retail investors will be the biggest challenge.
The Circular Economy & Industrial Leadership and the Finance & Economy units of the Joint Research Centre (JRC) of the European Commission unveiled their second proposal regarding EU Ecolabel criteria for retail financial products at the end of December.
The label is a tool that aims to increase sustainable finance flows.
The draft for the voluntary EU Ecolabel says that it intends to “promote products with a reduced environmental effect” to consumers by defining the criteria financial products need to fulfil in order to qualify for the label.
Inclusion of non-green companies
However, how the current methodology for the label is proposed and communicated may not be well understood by retail investors, observers say.
The draft label methodology promotes investments in companies.
It does this in two ways:
- by defining green thresholds on portfolio level for funds; and
- by defining whether companies’ ‘green economic activities’ fulfil thresholds, based on the EU’s taxonomy (classification system).
While the taxonomy is still under development, it will identify economic activities that significantly contribute to the achievement of its six environmental objectives.
The proposed EU Ecolabel methodology allows that only a percentage of the fund is invested in ‘green companies’.
For example, in the case of equity funds, at least 60% of the total portfolio value in assets under management (AuM) needs to be invested in companies, which have at least 20% of AuM invested in companies deriving at least 50% of their revenue from green activities.
The label seeks to take the green niche mainstream by including a wider range of companies, rather than only investing in green ones, an insider told Expert Investor.
Investors would quickly swamp the niche if the label only applied exclusively to green companies, the insider explained. This, and the need to provide diversification in assets, has led to the EU working group to lower the green thresholds.
Amendments in the proposal
Accordingly, one of the major changes in the revised proposal is the so-called three-pocket approach, allowing:
- Investments in companies with green activities
- Investments in transition activities of less-green companies
- Room for diversification
“These changes reflect the need for the EU Ecolabel to provide asset/fund managers with the flexibility necessary to invest in transition activities and also diversify their portfolio,” the draft report noted.
Dreblow commented: “If this initiative can’t be effectively communicated, there will be little incentive for the investment industry (Priips providers) to adopt it, unless financial incentives come in to play (eg cost of capital), which they just might, over time.”
Pablo Felmer Roa, senior legal advisor at think tank 2° Investing Initiative, argued that the methodology itself could be flawed.
He warned that retail investors will expect that investments in funds branded with the EU Ecolabel will lead to positive environmental change in the real economy.
Yet, he said, this cannot be ensured as the current methodology is designed to increase investment flows into companies instead of the growth of their green products.
For example, equity investments into Tesla shares would not necessarily lead to the growth of eco-friendly cars.
“That’s the real issue now in sustainable investment. What is the end of all this? What [approach] has solid evidence to base a theory of change on, because, at the end of the day, you are selling change,” Felmer Roa said.
While the label is still under development, the insider also highlighted that defining the aim of the EU Ecolabel in detail will be key going forward.
The second draft report updates the initial set of criteria proposed and serves as a background document for further planned discussions and meetings with stakeholders going forward.
It has proposed the following label criteria areas:
- Portfolio composition, in particular in terms of green economic activities (as defined by the EU Taxonomy)
- Exclusions based on environmental aspects
- Exclusions based on social aspects and corporate governance practices
- Information for retail investors
- Information appearing on the EU Ecolabel
The majority of stakeholders also commented that the label should not only focus on retail products, but include alternative investment funds and institutional funds, the report stated.
Citing Bloomberg and Efama, the report explained, that depending on the source, there are between 60,000 and 80,000 investment funds domiciled in the EU, with net assets amounting to around €15trn.
Of them, just 421 funds are currently marketed as green or sustainable – equating to between 0.5% and 0.7% of EU funds.
While a number of green and sustainable labels exist in Europe, they don’t support the flow of capital towards more environmentally sustainable economic activities, the report added.