Financial market players have ambivalent feelings about regulation. The default position is that regulation inhibits them, gets in the way, costs them money and should be resisted.
Since the crisis of 2008-9, financial firms have been like whipped dogs. Disgraced in the public eye by the huge losses generated by profligate home loans, they have had to accept most of what regulators threw at them.
But the tide has begun to turn. In the US, a populist, pro-capitalist administration since 2016 has chipped away several chunks of the defences against financial excess erected by Democrats after the crisis. The demolition continues, as the Securities and Exchange Commission mulls making it harder for shareholders to propose resolutions challenging corporate managers.
There is no sign of this about-turn in Europe yet. But the prospect of finance rallying its forces and going on the offensive is a real possibility to watch out for this year. Notably, the UK is now also governed by right wing, populist capitalists, who want to assert Britain’s right to diverge from EU rules.
Rule me!
There are some areas, however, where finance has been begging for regulation. A notable one is sustainable finance. Although this broad basket of activities has grown very rapidly without the aid of regulation, even leaders in the field appear bewildered. Like successful commanders who have captured an outpost more by luck than judgement, they admit that they do not know which way to turn next, and desperately want a map.
Hence the near-unanimous support in financial circles for the EU’s Sustainable Finance Action Plan, launched in 2018, and its centrepiece, the Taxonomy of Sustainable Economic Activities.
This voluminous encyclopaedia is exactly the kind of regulation financiers normally hate: a complicated web of specific rules, rather than a broad, clear set of principles. When implemented, it will inevitably be controversial and will need constant revision.
Yet market participants are so anxious to have an authority take away from them the responsibility for deciding what is green that they are delighted.
A dictionary
Many still think the Taxonomy is a rule book of what activities you can and can’t do. But understanding is beginning to grow that it is really a disclosure standard.
The Taxonomy is a tool with which financial players can describe their activities. Despite its complexity, the Taxonomy in use may be almost simplistic, with four bands. A fund manager, for example, will be able to say “60% of my fund is in sustainable activities, 10% is transition activities, 15% is enabling activities and 15% is other activities”.
This tells stakeholders something, but not a whole lot, about how green that portfolio is.
The desire for regulation was evident at GlobalCapital and Euromoney’s Sustainability MENA conference in Dubai last week. Bankers, investors and corporate issuers all called for regulation as the most important motor that would drive sustainable finance in the Middle East and North Africa.
Above all, they wanted clear disclosure standards. Investors trying to incorporate sustainability into their decisions need sensible, comparable information from issuers. Where disclosures are patchy or inconsistent, they struggle.
The MENA experts were cheered by the advances made in Europe, and generally agreed that, although international standards might need modifications to be applicable in the Middle East, it would be more efficient for MENA to follow global standards than create its own from scratch.
This is evidence that the EU’s Taxonomy is likely to have great influence, far beyond the borders of the Union. Those who devised it expected this: an international dimension was always a central part of the Sustainable Finance Action Plan.
Now it gets tough
The Taxonomy will have controversial aspects — the detail of how green a technology has to be to be considered sustainable. But for the moment, financiers can relax and leave the corporate sector and NGOs to argue about those. Their own job will be to use the classifications.
But the markets’ enthusiasm for sustainable finance regulation is about to face a new test.
The European Securities and Markets Authority has set out its Sustainable Finance Strategy. This is one of those regulatory documents that is at once clear and opaque. Esma has set out what it wants to do in clean, simple language — but the statements are necessarily general and vague. It is difficult to grasp what will be the pinch points — the rough bits that really bite.
One part that will start to emerge from the murk soonest is the Regulatory Technical Standards that will set out exactly how firms have to comply with the disclosures they are required to make, using the Taxonomy.
This is where the Taxonomy will start to get real for finance specialists. Theory is one thing; putting specific disclosures down in writing is another.
Funds will, in Esma’s words, have to disclose, from March 2021, “the principal adverse impacts of their investment decisions on sustainability factors”.
This is quite revolutionary in finance — it covers the outward facing impact of their investments. What precisely will investors have to tell their clients — and what must companies tell investors?
Will investors that own Unilever bonds need to know, for example, the effects on rivers and oceans of all the shampoo and detergent that gets washed down drains?
A public consultation on the rules will begin soon. It will show whether the financial sector still feels the same thirst for regulation on sustainable finance as it has up to now, or whether financiers will revert to their usual posture of kicking back against intrusive regulation.
How hard to squeeze
As for regulators, what should they do? How tough should they be?
The starting point should be: tough and stretching, but not impossibly so — leaving room to tighten the rules quite soon if necessary.
Getting the financial sector to focus clearly and fully on sustainability is hugely desirable. But policymakers should not kid themselves that it is going to make all the difference. Rules can make it easier for financial actors to make better choices — but they will still have to make the choices.
They have had plenty of opportunity up to now to make good choices, and have not done so. You do not need complex disclosures of carbon footprints and climate strategies to know that oil companies are producing fossil fuels, the cause of climate change — yet people still invest in them.
The finance industry's clamour for better disclosure is partly honest, but partly also a delaying tactic. It could cut out much of the dirt now.
The most direct way governments can green the economy is not by changing incentives for financial markets, but by tough actions to regulate it directly.
It has been perfectly obvious for ages that plastic bags are terrible for the environment. But the private sector has not stopped using them. But when Kenya and Tanzania banned them completely, at short notice, in 2017, everyone had to adapt.
Among them was Aramex, a freight forwarding company making impressive efforts to green its operations. As Raji Hattar, the company's chief sustainability officer, made clear at the Sustainability MENA conference, the firm just had to comply — and it did.
The power of direct, on the ground regulations like that, which can cut out years of dithering and evaluating data, was summed up by Hattar when he called — a surprising demand from the corporate sector — for regulators to apply "the stick more than the carrot".