Be Careful – Disclosure Regulation May Not Disclose Very Much…

By Søren Rahbek, Diretor I August 18, 2023

The Sustainable Finance Disclosure Regulation (SFDR) requires Financial Market participants and Financial Advisors to report on the consolidated impact on 14+2+2 mandatory (+2 voluntary) Principal Adverse Impact indicators (PAIs). The first report had to be made by June 30th, 2023, covering 2022.

To understand the current status of reporting, CMP has done a collection of data from the PAI reports published by a selection of the biggest banks, as well as big pension companies and important fund providers, all from Denmark.

The reports paint quite a varied picture.

It is fundamentally important to acknowledge that this is still very early days for the SFDR reports. There is still important uncertainty about the implementation of the regulatory requirements and more importantly, data is still not very strong.

The result of each PAI depends on the underlying portfolio, which may contain more or less ‘dirty’ companies. Data on each investment will vary in both quantity (how many data points are provided) and quality (whether data is reported, estimated, or simply not available).

So, the result for a given total portfolio at the entity level will thus depend on the actual holdings, the reporting entity’s interpretation of the regulatory formulae, and the data provider quality and coverage. A low level of i.e., CO2 emissions can thus be the result of a CO2-aware portfolio, limited or misleading data, or making a wrong calculation. All these factors are likely to be in play.

The Results

Interestingly, given the focus of the regulation on providing transparency to investors, in some cases, it is surprisingly difficult to find the relevant report. The following are just some observations on the content.

One bank has as the only institution decided – against regulation – to report its CO2 footprint and its CO2 intensity based on scope 1 and 2 emissions, reducing the PAIs by a factor of 5.5, which makes it stick out positively, based on the face of the reporting. If this bank was also considering Scope 3, it would bring it in line with its banking peers.

Another bank seems to have found investments with total equal pay between the genders, which unfortunately is not really believable. On the other hand, these companies also have a rather low share of women on the board. Both observations reflect that data is not fully available. The bank in question provides good explanations for its figures, which underlines that all reports must be read with care.

In some cases, such as CO2 emissions and related PAIs, it makes sense to report the data you have, even if it does not reflect all investments. In the case of CO2, it makes sense to report the data as it is and supplement (as the above-mentioned bank does) with data on the coverage ratio (the share of investments where data is available).

However, it is debatable whether it makes sense to report average pay differences based on all investments, regardless of whether data is available or not. Using all investments in the denominator will of course lead to much lower results than using the number of investments where data was in fact available and thus distort the message.

A pension company seems to have calculated the share of women on boards as Women/Men rather than Women/total. To be fair, the PAI was changed, but it is an indication that even the most professional institutions are struggling a bit to get this new reporting right.

Looking at other data, another big pension company apparently has a rather ‘dirty’ portfolio, with significantly more CO2 emissions than average. In fairness, it points this out in a separate report on its negative environmental impact (in Danish) and explains it by its investments in FL Smidth, which actually assumes a huge responsibility for the CO2 emissions of its customers (Scope 3 emissions). However, the pension fund also reports a significant exposure to the fossil fuel sector.

There seems to be some confusion regarding the share of non-renewable energy consumers and produced. Some report two numbers, others just one. One bank apparently has made investments in companies with a much larger share of renewable energy (use and/or production?) than the other investors.

Investment in biodiversity-sensitive areas seems (based on industry news) to be the next focus point for ESG investors following CO2 emissions. Two pension providers report that they have investments in such sensitive areas at a level that is 400 times the level of the other reporting entities. Some report 0%. Again, this seems to indicate that data has not been broadly available, and it is indeed also a difficult data point to measure.

Almost the same level of differences applies to emissions of water and tons of hazardous waste.

There is generally a low level of investments in companies, which have been involved in violations of the UNGC principles or the OECD Guidelines for multinational enterprises, however, the share of investments in investee companies which are not compliant to Guidelines for Multinational Enterprises is surprisingly high at 40,3%.

None of the investors had any investments in the manufacturing or selling of controversial weapons – in 2022.

The CO2 intensity of investee countries (issuers of government bonds) varies very significantly, which obviously can reflect portfolio composition, where a focus on EU countries should lead to lower levels compared to investments in India or Brazil.

There is only limited reporting on a number of investee countries subject to social violations or share of investments in real estate related to fossil fuels.

Not surprisingly, only the pension companies report on direct investments in energy-inefficient real estate. The differences found are likely to reflect the portfolio.

Half of the reporting entities have chosen to report on the share of investments in companies without carbon emissions reduction initiatives, as one of the voluntary PAIs, which reflects the obvious special attention given to the CO2 emissions. Having a carbon reduction initiative seems to be a ‘sine qua non’.

How To Use These Reports?

For now, it is fair to say that the disclosure reports do not disclose very much. In a year, investee companies will provide better and broader data, and financial market participants are likely to have calibrated their models and benchmarked with others. Then it will be possible to have meaningful discussions on both the level and direction of the Principal Adviser Impact indicators.

For now, data should be read with care and neither regulators nor the press should jump to conclusions about the sustainability profile of specific institutions.

Capital Market Partners will of course be more than happy to engage in further dialogue on the status and reporting of ESG data.

About CMP

Our name, Capital Market Partners, reflects what we define as our core service: Business understanding based on extensive experience in applying technology in the capital market area.

As a business partner, we offer consulting services based on our combination of business understanding and IT know-how. Our work analyzes, implementation of IT systems and other projects supports strategic decisions at different levels in complex business contexts.

For further information – Please contact:

Lars Christiansen

Managing Partner

Tel: +45 2993 4678