Evaluating Regulatory Effectiveness for Sustainable Investment
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Responsible Investing
Published
October 28, 2024
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5 mins
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Aegon Asset Management
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A new overnight train from Brussels to Berlin, the European Sleeper, has recently been launched in a growing market for train travel in Europe. Deutsche Bahn estimates as many as 50% of travellers between the two cities is taking the train these days, despite the journey taking up to 9 hours versus less than 2 on a plane.   


This is another piece of anecdotal evidence, alongside a doubling of vegans1 and the meteoric rise of the second-hand fashion industry2, of European commitment to lead more sustainable lifestyles. But there are signs this commitment might be wavering when it comes to investments. 

The Global Sustainable Investment Alliance, in its latest report issued in November 2023, highlighted that sustainable investments in Europe grew from USD 12 trillion in 2020 to USD 14 trillion by the end of 2022, but this growth failed to keep pace with the broader investment market.  The report estimates a decline in the proportion of sustainable investments from 59% in 2014 to 38% in 2022. The report suggests this may be due to increased regulatory requirements and a move to more conservative fund labelling and reporting – a reversal of previous greenwashing behaviour with perhaps some added greenhushing too. 

It is true of course that the EU has been at the forefront of integrating sustainability into its financial system for some time, with a wide array of regulations trying to bring some order to a chaotic, fast-growing industry, while attempting to harness its potential environmental and social impact to achieve public policy goals.   

The cornerstone regulation of this agenda is the EU Taxonomy, which provides a classification system for environmentally sustainable economic activities. The Sustainable Finance Disclosure Regulation (SFDR) requires financial market participants to disclose how they integrate sustainability risks into their investment decision-making processes, aiming to prevent greenwashing and improve access to reliable information about the sustainability of investment products – in the hope that investors will then allocate more capital to sustainable economic activities.  The EU’s Green Bond Standard aims to enhance the credibility and comparability of green bonds and facilitate green bond market growth, while further regulations aim to provide passive investors with reliable and comparable information on the carbon footprint and sustainability performance of benchmarks.  All of these regulations are underpinned by the Corporate Sustainability Reporting Directive (CSRD), which expands the scope of sustainability reporting requirements for companies operating in Europe and mandates disclosures on ESG risks and impacts. Finally, the Corporate Sustainability Due Diligence Directive (CSDDD) requires European companies to identify and address adverse human rights and environmental impacts within their operations and across their global value chains. 

This regulatory agenda aims for nothing short of a revolution in how Europeans invest, but the question remains: is it increasing or reducing the net sustainability impact of European investors on the world? The answer is not in SFDR’s periodic disclosures or CSRD-compliant reporting.   

Impact through capital allocation 

In essence, EU sustainable finance regulations are attempting to increase the supply of private capital for sustainable economic activities and, by extension, reduce the supply of capital for other – or unsustainable – activities. The ultimate objective is to reduce the cost of capital for those activities defined (ideally by the EU taxonomy) as sustainable and increase that for activities deemed to have significant ‘adverse impact’ on society or the environment, with the focus of regulations so far being on public markets. 

There has been limited academic research into the potential of ‘positive screening’ (or positive selection of issuers based on the sustainability of their economic activities) to reduce the cost of capital for the public issuers selected by such approaches. Pricing studies conducted by the Climate Bonds Initiative (CBI) point to the existence of a “greenium”, or a pricing premium investors are willing to pay for green bonds over their conventional counterparts.  However, CBI’s latest available research (H1 2023)3 observes this effect for only 16 of the 111 green bonds in its sample.  A 2022 study4 using the largest global green bond dataset compared to any previous studies, found that the greenium on average amounts to, sadly, just over one basis point. 

There is also limited evidence to support the effectiveness of regulations or voluntary exclusionary policies with the objective of increasing the cost of capital for unsustainable activities (see my article on divestment for a summary), at least in public markets. 

The overall financing structure of European firms further reduces the potential impact of capital market sustainability regulations on their cost of capital. In 2022, the European Central Bank estimated5 the outstanding volume of bonds relative to bank borrowing by euro-area firms to be around 30% (versus around 65% in the United States). Private financing remains dominant for European firms, therefore somewhat insulating them from the sustainability preferences or regulatory demands of capital market participants. 

The picture is not as black is it may appear from the evidence of course. It is likely that companies on the smaller end of the spectrum do experience changes in the cost of capital as a result of investors’ aggregate sustainability-related capital allocation decisions. Even then, however, the extent to which companies improve the sustainability of their activities in response to cost of capital incentives remains unclear. Without accompanying regulation for the real sector, any increase in the cost of capital resulting from reduced investment may be passed on to consumers – just ask tobacco companies – or worse, be opportunistically targeted by other investors not bound by the same regulations or preferences. 

Impact through active ownership 

Investors do not solely influence companies by voting with their feet: as active financiers and stewards of the companies they invest in, they can exert positive influence and encourage more sustainable business practices, especially as shareholders. 

EU sustainable finance regulations also aim to co-opt this channel for positive impact. By encouraging more standardized disclosures from players across the investment value chain, the hope is that what gets measured and reported gets prioritized and addressed. Thus SFDR, for example, requires asset managers to disclose the aggregate “Principal Adverse Impacts” of all portfolios they manage, and the actions they are taking to address such impacts - which are usually a mix of exclusion policies and engagement activities. The logic goes that data scarcity on such impacts can be addressed by investors by collectively asking companies to disclose it, which will then prompt companies to improve on those metrics over time. 

Yet the financing structure of European companies also plays a role here. The relative importance of minority shareholders and bondholders to European companies’ capital structure remains lower than that of private lenders and shareholders, with a direct implication for their influence. Diversified portfolio investors typically hold very small stakes, while bondholders are usually limited to expressing their views and preferences through simple dialogue.   

Shareholders can and do indeed vote at shareholder meetings, but their ability to do so, and more importantly, to put resolutions up on the ballot of such meetings is far from homogenous globally or even within Europe. In some jurisdictions it is rather easy for companies to reject shareholder proposals before they get to the meeting, significantly hampering shareholders’ levers of influence too. Unfortunately there is no regulation to harmonize shareholder rights and corporate governance principles across Europe. 

At the same time, regulators and beneficiaries are struggling to make sense of mountains of largely qualitative reporting asset managers and owners are making available on their engagement and voting activities. Such activities and attribution of their results are challenging to report objectively, comparably and concisely, yet they may represent the most viable path to real world impact for portfolio investors in public markets. 

A way forward 

In summary, it may be time to take a step back to academically evaluate the effectiveness of the regulations implemented so far in achieving their high-level objectives. Such an evaluation could not only help legislators make any necessary course corrections, but will also help complement the change agenda with regulations to help public market investors enhance their influence over companies and to further mobilize private financing towards the same objectives. Further work is needed to ensure sustainable investment delivers real world change. Demonstrating real impact will only help further mobilize investors to deliver a more sustainable economy for all. 

[1] According to Veganz, a Berlin-based Vegan supermarket chain, the number of people identifying themselves as vegans in Europe has doubled from 1.3 million in 2016 to 2.6 million in 2020.

[2] According to Cross-Border Commerce, the resale fashion market is currently growing 11 times faster than traditional retail.  

[3] cbi_pricing_h1_2023_01f.pdf (climatebonds.net)

[4] Lau, P., Sze, A., Wan, W. et al. The Economics of the Greenium: How Much is the World Willing to Pay to Save the Earth?. Environ Resource Econ 81, 379–408 (2022). https://doi.org/10.1007/s10640-021-00630-5

[5] Firm debt financing structures and the transmission of shocks in the euro area (europa.eu)  

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Aegon Asset Management

We are active global investors. In a complex world we think and act across traditional boundaries. We organize our teams globally by asset class, to bring the breadth and depth of our investment and research capabilities together for clients across the world. 

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