All the Limitations of European Legislation on Sustainable Investment
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All the Limitations of European Legislation on Sustainable Investment

INSTITUTIONAL INVESTORS MAY LACK THE RESOURCES AND INCENTIVES NECESSARY TO COMPLETE THE STEWARDSHIP TASKS THE EUROPEAN UNION ASSIGNS TO THEM, WHILE ESG INDEXES AND RATINGS ARE SHORT ON TRANSPARENCY AND CONSISTENCY, ACCORDING TO RESEARCH BY BALP AND STRAMPELLI

Promoting Environment, Sustainability and Governance (ESG) investment is key to reaching the goals of the European Green Deal, the European Union strategy to become climate neutral by 2050. To this end, an articulated set of norms promotes the role of institutional investors in driving a shift towards sustainable finance in Europe, with a thinly concealed hope of spurring a “Brussels effect”: since some of the obligations cover also third-country financial market participants that sell financial products in the EU, European requirements could become the international standard.
 
In this framework, institutional investors are required to promote ESG goals by exerting influence over investee companies (the so-called stewardship function). And yet, a paper by Bocconi Department of Legal Studies scholars Gaia Balp and Giovanni Strampelli argues that there are limitations to the reasonable reach of investor action in face of the scale of the challenges at stake. “Some of the limitations are due to difficult-to-overcome external factors” Professor Strampelli said, “but others could be corrected by the European legislature.”
 
The paper reviews current and proposed European legislation on the topic and then exposes its shortcomings.
 
Lack of resources and collective action issues constrain the stewardship role. “The evidence shows that the stewardship teams of major institutional investors are significantly smaller than the size of the task they are entrusted with,” Professor Balp said, “and stewardship teams appear to be largely understaffed relative to the number of companies covered by stewardship initiatives.” The main available stewardship tool is meeting the board, or management, of portfolio companies to discuss ESG issues, and the lack of resources translates into the chance of meeting only a tiny share (perhaps 10%) of them. Furthermore, with the growth of indexed, passive investment, a free riding temptation arises: “Each fund tracking the same index holds the same stocks in the same proportion, and funds managed by other index fund managers will capture exactly the same returns from the stewardship activity of an investor,” Professor Strampelli clarifies.
 
  

End-investor preferences are currently driving the rise in ESG investment in Europe and elsewhere, but preferences could change, especially because “evidence is still mixed concerning whether or not sustainable investing holds promise on delivering financial returns that are competitive vis-à-vis non-ESG investing,” the authors write. This could encourage institutional investors not to exert too much effort until the situation is clearer.
 
What is within the EU legislature’sreach is the quality and consistency of the information made available to ESG investors. EGS indexes and ratings lack transparency and wildly differ in their outcomes, with the same company receiving opposite scores or classification by different providers, thus raising doubts about its real sustainability. Furthermore, the indexes and ratings industry is oligopolistic and tainted by widespread suspicions of conflict of interest, since these providers can, and sometimes do, provide other services to the same companies. “The European Commission could take some regulatory action on the issue,” Prof. Strampelli concluded.
 
Balp, G., Strampelli, G.Institutional Investor ESG Engagement: The European Experience.” European Business Organization Law Review 23, 869–904 (2022). https://doi.org/10.1007/s40804-022-00266-y.

by Fabio Todesco
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