In recent years, and certainly since the Sustainable Finance Disclosure Regulation (SFDR), interest in ESG-focused investment products has exploded. Alongside this interest, however, has come the problem of greenwashing: how can investors be certain that the funds in which they’re investing are as “green” as their issuers claim?
From the domain of concerned individuals and outspoken organisations, the issue of greenwashing has grown into a mainstream discussion. There is currently no EU-wide label for ESG funds, but rather a patchwork of local standards and varying definitions. For instance, when describing how it avoids greenwashed bonds, the LGX DataHub--the Luxembourg Stock Exchange’s digital platform for listing sustainable bonds--doesn’t mention external criteria but rather of using human beings (rather than artificial intelligence) to find the use-of-proceeds or sustainability-linked language and, based on that, making a judgement call.
The European Securities and Markets Authority (Esma) has recently published two papers that look more closely this issue. The first analyses while the second explores whether, in the sustainable debt market, from an ESG pricing effect.
At a recent Esma webinar, the authors of these two papers introduced some of their findings.
Naming conventions
“That’s a source of concern,” said Julien Mazzacurati, talking about the lack of an EU-wide label on ESG funds and the reliance, instead, on voluntary self-labelling and other local standards. Along with Adrien Amzallag and Natacha Mosson, Mazzacurati cowrote the Esma paper on naming conventions and the use of ESG language within the EU fund industry.
Prior research has shown that fund names can influence investors, Mazzacurati explains, contextualising his findings: “They can act as a powerful and very useful signal. But they can also misinform investors.”
One finding from the study was simply how much more prevalent ESG-related language has become. Over the last decade, Mazzacurati explained, the share of funds with an ESG-related word in their name has risen from 3% (2013) to 14% (2023). “That’s a very steep increase,” he commented, adding that the curve sharpens after the Paris Agreement in 2015. In parallel, ESG-related language also appears more and more in the related documents, such as the fund’s key investor information document (KIID) or marketing materials.
Another finding is that the type of ESG-related word used in the fund name tends to be vague, for example “ESG” or “sustainable.” Mazzacurati suggested that, in doing this, fund managers provide themselves with flexibility in their investment strategy or portfolio choices. Unfortunately, he pointed out, this vagueness also means that the fund’s actual intention remains unclear to the investor.
And, more than ever, investors want to know: Mazzacurati reported that funds with ESG-related language in their names are attracting more money than their non-ESG counterparts.
The green-premium, aka “greenium”
Why would investors accept lower yields but pay the same, or more, for an ESG bond (rather than a non-ESG bond)? That phenomenon--because, indeed, investors do this--suggests the existence of an ESG pricing benefit, or the ability of issuers to hike their price (add a “greenium”) because investors are willing to pay more. This was the subject of the second Esma paper discussed during the webinar.
Sara Balitzky, who cowrote the paper with Paul Reiche, explained that investors are indeed willing to pay extra or accept lower yields in exchange for having a sustainable impact.
As for why, she continued, several explanations have been proposed. One is the intrinsic motivation of the investor, i.e. there are some investors who are motivated by effecting a sustainable human presence in the world rather than (merely) by profits. Another explanation is the very high demand for ESG-level debt, a demand which is larger than the supply. And a third, according to Balitzky, is that the sustainability profile of the issuer, or equally of the debt itself, reduces the perceived overall risk of the issuer.
Despite analysing several ESG bond types, the researchers were unable to confirm a “systematic and consistent” pricing advantage within any of those bond types. However, they did find that ESG bond issuers have, in the past, benefitted from pricing premiums based on their issuer characteristics, possibly a “first-mover advantage” or due to their credibility amidst mounting concerns about greenwashing. This trend, however, has stopped.
They also found that when issuers make public ESG commitments, this has no effect on the pricing of their bonds.