Imposing Sustainability Disclosure on Investors

Does It Lead to Portfolio Decarbonisation?

March 15, 2024Published by European Corporate Governance Institute

EU funds lowered their carbon emissions following the mandatory sustainability reporting brought in by the Sustainable Finance Disclosure Regulation (SFDR), finds this paper for the European Corporate Governance Institute.

The results show a pattern of significantly lower portfolio emissions following SFDR implementation compared with control funds – at 13.7% for scope 1 emissions and 6.6% for scopes 1, 2 and 3 combined.

The control group are funds held to the purely voluntary sustainability reporting standards of the UN’s Principles for Responsible Investing (PRI). The paper’s findings are consistent with previous literature which suggests that voluntary disclosure requirements, unlike mandatory ones, do not necessarily encourage emissions reductions.

Observable emissions reductions are partly attributable to real-world decarbonisation of portfolio assets, which may have been induced by investor pressure, say authors Jiyuan Dai, Gaizka Ormazabal, Fernando Penalva and Robert Raney.

The results were also found to be driven by sales of high-emitting firms and purchases of lower emitting ones by investors seeking to adjust their fund’s emissions profiles. It is uncertain from this research whether such changes led to the decarbonisation of assets leaving the funds.

Notably, the authors find evidence of above average reductions in scope 3 emissions within the subset of firms that remained in the fund portfolio over the whole sample period.

The SFDR introduced the first wide-ranging sustainability disclosure mandate imposed on investment funds. As per the SFDR, funds self-categorise as Article 8 (ESG-related) or Article 9 (those with sustainability objectives), with specific reporting requirements for each group.

The authors used the introduction of the SFDR as an exogenous shock to compare the weighted average carbon emissions of Article 8 and 9 SFDR funds with the PRI control group.

Using a wide sample of international investment funds across Europe, the US and the rest of the world, the authors show that emission reductions are “more pronounced for funds with higher levels of portfolio emissions prior to the SFDR”. Indeed, funds reduced their holdings in sample firms with the highest pre-SFDR emissions by an incremental 22% to 29%.

However, funds already exposed to mandatory disclosures before the SFDR had below average emissions reductions.

Two significant limitations of the study are that it exclusively focuses on active equity funds, and that it only considers carbon emissions at the expense of other sustainability criteria. The authors say their model can be extended to cover other sustainability features and areas of the financial sector in follow up research.

The authors recommend that future research should also look at possible unintended consequences of disclosure mandates, such as the outsourcing of emissions and other broader market-wide effects of reporting mandates along the supply chain.

This page was last updated March 21, 2024

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