An analysis by Marion Ehringhaus and Michael Diaz, Co-Head Sustainable Finance at Q_PERIOR
The topic of sustainability has become an integral part of the financial sector. A few years ago, sustainable funds or strategies were niche products that were often considered too expensive and underperforming. Today, “green” solutions are standard. But as demand for green investments grows, so do doubts. What exactly does sustainability mean when it comes to investments? And how can it be ensured that ESG is inside where ESG is on the outside? Because the danger of so-called greenwashing is growing. Providers are repeatedly criticized because their promises turn out to be empty. Funds declared green invested more in fossil fuels during the energy crisis, for example, thereby increasing their own CO₂ profile. Banks or fund providers advertise sustainability, but in reality pursue business practices that can hardly be reconciled with this claim.
But sustainability is no longer a bonus. Rather, it is the basis for future viability. In order to secure the positioning of Switzerland as a financial location, full transparency for investors in the fight against greenwashing is key. In conversations we have had with regulators, banks and representatives of the asset management industry, it shows that the individual players focus on different levels, such as company, product and customer.
The intention decides
The regulator is pursuing the goal of creating good framework conditions so that Switzerland as a financial center can secure its leading role. Sustainability is also a key factor for international competitiveness, especially for Switzerland as a center for cross-border wealth management. Accordingly, the federal government wants to create full transparency for investors and thus enable optimal investment decisions. An important lever for this: a uniform understanding of the term sustainability.
To ensure this, the regulator focuses on intentionality. This means: A product is considered to be sustainable if the defined investment goal, in addition to financial returns, is that the product is either compatible with one or more sustainability goals or makes an active contribution to achieving these goals. The envisaged sustainability goals must be specifically named and, if necessary, it must be explained how these goals are being worked towards.
Financial products that reduce ESG risks are therefore not considered sustainable. According to the regulator, the consideration of ESG risks falls under the usual due diligence requirements and is not enough for a product to be declared sustainable.
The question of intentionality thus comes into focus. What does a product want to achieve? The investment strategy and process take a back seat to assessing sustainability. For example, a “best in class” approach can be sustainable if the companies in the fund have a good transition plan for the path to net zero. Such a fund would be compatible with a sustainability goal. However, if the companies included do not have such a plan, the fund is not considered sustainable.
Unlike the European Union (EU), the Swiss regulatory authorities do not want to define any detailed requirements. No threshold values or concrete calculation methods should be prescribed. A principles-based approach is followed. This should be implemented using a common language and not through comprehensive, exhaustive regulation. The aim is to ensure that investors have correct information and that products are advertised honestly.
Clarity in advice
The banking industry is also pursuing a similar goal – through free self-regulation. For example, at the beginning of 2023, the Swiss Bankers Association introduced mandatory self-regulation for its members with transition periods. A major focus is on the customer advisory process. Both in investment advice and in asset management, sustainability and customer preferences should be integrated as important points in the advice.
Investors should thus be able to make informed decisions. To do this, the customer advisors must understand what the customer is looking for in order to offer the right products. If there is no product that matches the customer’s preferences, the self-commitment states that no other, less suitable product may be sold to the customer. Customer requirements and investment product must match and this matching must be well documented – for private investors as well as for professional investors.
A central point here is the training and further education of customer advisors, as they play an important role in the new advisory process. The standard of advice is to be increased, transparency and clarity are to be strengthened, and competition is to be intensified as a result. The voluntary commitment is coordinated with international regulation. The Bankers Association hopes that this voluntary commitment will strengthen the Swiss financial center in this way.
avoid discrepancies
The asset management industry is also clearly committed to the fight against greenwashing. Allegations of greenwashing, whether justified or not, would damage the integrity and credibility of the industry and thus pose a major reputational risk, argues the industry association Asset Management Association Switzerland (AMAS). Accordingly, the topic must be tackled aggressively and the industry must be part of the solution.
Therefore, in September 2023, AMAS will also introduce mandatory self-regulation for members, which applies to both the institute level and the product level. The former addresses governance, investment policy and guidelines as well as risk management. The products deal with classification, sustainability approaches, reporting and sustainability or investment goals. The AMAS categorizes these into financial performance, value orientation, i.e. the alignment of investments with individual values and norms, and positive change, i.e. impact investing. This is to avoid discrepancies that can arise when the strategy and investment objective do not match.
The motto for AMAS is: Engagement over Exclusion. The focus is on actively working with companies rather than simply excluding stocks that don’t fit sustainability profiles.
A good first step
Basically, it can be said that the Swiss approach is different overall than, for example, the EU approach. While the EU relies on comprehensive, detailed regulation, Switzerland is pursuing a principles-based approach. Self-regulation and transparency are very important here. Customers must be able to see what sustainable products contain and whether they contain what is written on them. This is how Switzerland strengthens consumer protection – and protects credibility. A central point, because trust is the most important asset in the industry.
After our expertise the upcoming and already applicable regulations to combat greenwashing are therefore important and correct. However, they can only be the first step, others must follow. Because after the definition of sustainability, the question must be asked: Which instruments of the financial market actually promote the sustainability of our economy and industry? Which strategies and products are effective? If we have answers to these questions and set the right incentives, the financial market can become a powerful player in sustainable transformation in the future.