Investors usually have a healthy interest in numbers. But nowadays they are increasingly preoccupied with letters, and three in particular. ‘ESG’, which stands for ‘environmental, social and governance’, is playing an ever-greater role in investment decisions. 

In 2022, 76% of US and European fund managers were incorporating ESG criteria into their fixed-income investments, up from 42% in 2021. On the flip side, funds that purposefully ignore ESG are being shunned by the investment community. There are sound reasons for this selective pressure. 

Intuitively, it seems obvious that companies boasting good governance, social responsibility and environmental stewardship should also be fiscally prudent and produce reliably positive returns. 

This is indeed borne out by research, with academics noting that an “overall ESG combined score is positively and significantly associated with firm value” and “environment, social and governance scores have positive and significant relationships with firm profitability.” 

Experts concluded that “investing in high ESG performance promises financial return for the firm in terms of both value and profitability.”

The problem for investors is that ESG is difficult to define in practice. Whereas numbers do not lie, with a profit being a profit and a loss being a loss, the extent to which a company is socially and environmentally responsible is often hard to gauge.

ESG vs Greenwashing

Indeed, most businesses have long been keen to promote acts of corporate social responsibility, such as introducing recycling policies or banning single-use plastics, while conveniently ignoring the negative externalities arising from business activities ranging from energy use to company travel.

This corporate greenwashing is a concern for investors keen to separate truly responsible activity from overblown ESG claims. 

Overclaiming has been found to be rife in corporate communications, with 68% of US executives admitting to greenwashing and two thirds of business leaders globally confessing that their companies’ sustainable initiatives may not be genuine. 

Greenwashing is particularly an issue in the energy industry, which is the world’s biggest source of carbon emissions. Energy companies are naturally keen to advertise their decarbonisation efforts, yet at the same time many of them are major polluters. 

This means investors in energy infrastructure face a tough time in choosing ESG-compliant investments. 

To take an example, the European Union’s plans for green hydrogen—considered a vital tool in moves to decarbonise energy and several industry and transportation sectors—are also potentially “a gold standard for greenwashing,” said pressure group Global Witness in February 2023.

“The European Commission’s draft rules for what constitutes green hydrogen—which should be produced with renewables—allows it to be made with electricity from coal or fossil gas power plants,” blasted the campaigning body. 

Recognising these issues, regulators around the world are introducing tighter and clearer rules over what can be defined as sustainable or ESG-compliant. 

Leading the charge is the European Union, which has a Sustainable Finance Disclosure Regulation (SFDR) package that from March 2021 has imposed mandatory ESG disclosure obligations for asset managers and other financial markets participants.

Within the SFDR, funds can have three levels of sustainability, defined under the regulation’s articles 6, 8 and 9. Article 6 funds have no sustainability scope whatsoever while article 8 or ‘light green’ investments have at least some environmental or social impact. 

Of greater interest to ESG-focused investors are article 9 or ‘dark green’ funds. These are investment vehicles “Where a financial product has sustainable investment as its objective and an index has been designated as a reference benchmark.”

Companies promoting article 9 funds need to provide Information on how the designated index is aligned with that objective plus an explanation as to why and how the fund differs from broader market peers. Furthermore, according to the accountancy firm Deloitte, article 9 funds must:

  • Refer to a Paris Agreement-aligned benchmark if aiming to reduce carbon. 
  • Incorporate good governance into the investment strategy. 
  • Do no significant harm by incorporating social safeguards. 

What kinds of energy infrastructure could investors back to take advantage of this designation? 

The UK’s NextEnergy Solar Fund was one of the first to point out that its renewables and energy storage projects were fully aligned with article 9 because they helped mitigate climate change and did no significant harm, meeting minimum safeguards for sustainable investing and human rights. 

Another vehicle signing up to article 9 is Ireland’s Invesco Global Clean Energy UCITS exchange traded fund, which uses the WilderHill New Energy Global Innovation Index as a benchmark. 

The index focuses on companies specialising in wind, solar, biofuels, hydro, wave, tidal, geothermal and other renewable energies, as well as energy conversion, storage, conservation and efficiency, plus materials relating to those activities and more generally carbon and greenhouse gas reduction.

These moves suggest stakes in energy storage companies will qualify as SFDR article 9 investments, particularly since battery plants will be key to reducing emissions by enabling the integration of higher levels of renewables on the grid. This is not a given, however. 

The German sustainable infrastructure investment fund KGAL, for example, has launched a renewables project development fund called ESPF 5 that is regulated under article 9, but has also recognised that such projects might not automatically qualify for the standard. 

And Gresham House’s energy storage fund, while focused solely on developing battery plants, has shied away from claiming sustainable investments as defined by the SFDR. “The company promotes environmental or social characteristics but does not have sustainable investment as its objective,” it says. 

Making progress on our ESG commitments

At Pacific Green, we are keen to offer investment partners the opportunity to undertake article 9-compliant transactions yet are also mindful of our duty to provide accurate and transparent reporting under the SFDR and equivalent regulations outside the European Union. 

For this reason, we are keeping the reporting status of our energy storage projects under review and at the same time making progress with a wide range of ESG commitments.

Moving forward down this path is integral to our corporate values of sustainability, innovation, collaboration and adaptability. There will be more to come, so watch this space. 

Publish date: 26 June, 2024