Clearing the path through labels and certifications
The increasing prominence of ESG (Environmental, Social, and Governance) issues, particularly environmental concerns, has led to the emergence of numerous labels and certifications. Facing the abundance and diversity of available options, both companies and their shareholders may feel disoriented, as ESG performance and its measurement are becoming key criteria for the company’s attractiveness to stakeholders. Therefore, it becomes crucial to navigate within this maze of thematic or sectoral labels, each pursuing different objectives. Indeed, their proliferation can lead to confusion for both companies and investors. As a result, investors tend to rely on French and European regulatory frameworks, while companies juggle between different labels and certifications. Furthermore, while these initiatives have gained considerable enthusiasm, obtaining and maintaining such certifications require significant financial and operational resources for the company. Beyond complexity and costs related issues, the question arises as to whether labeling provides an objective and relevant measure of transition progress towards an environmentally friendly production and consumption model.
In order to address these questions and shed light on the challenges of labeling, we have chosen to interview Ms. Giorgia Davidovic and Ms. Charlotte Allard, respectively Sustainability Manager at Reporting 21 and Sustainability Manager at the Sparring Capital Group, in this newsletter.
Cross interview – The thicket of labels with Charlotte Allard and Giorgia Davidovic
Charlotte Allard, Manager Sustainability Climate, Sparring Capital
Giorgia Davidovic
There has been an acceleration in the use of labels and certifications, at management companies, funds or holdings levels. How do we explain this phenomenon? Is it the proof of a sincere desire to improve practices, or the sign of a greater need for clarity in ESG practices, which are currently quite heterogeneous?
Charlotte Allard
The acceleration in the use of labels primarily demonstrates a growing awareness of ESG issues at all levels, at both investors and portfolio companies levels. Investors, enterprises, and consumers are increasingly aware of risks associated with unsustainable practices and actively seek ways to contribute positively. The use of ESG labels or certifications is one such way.
The use of labels and certifications helps to improve practices by encouraging companies to adhere to high sustainability and responsibility standards. These labels can also enhance transparency and visibility of a company’s ESG practices, going beyond mere declarations and becoming a compelling factor in establishing business relationships, for example.
However, it’s crucial to note that the growing use of ESG labels can also present certain challenges. Some actors may seek to “greenwash” their activities by using ESG labels without a genuine commitment to sustainable practices. Therefore, it’s essential that the chosen labels are rigorous, transparent, and verifiable to distinguish genuine sustainable initiatives from superficial marketing attempts.
Giorgia Davidovic
The acceleration in the use of ESG labels (such as B Corp, Lucie, etc.), certifications (including ISO), and legal statuses (such as Société à Mission and ESUS) is particularly noticeable in recent years in the corporate world, spanning from SMEs to large publicly traded companies. This choice is driven by the desire to showcase sustainable practices to various stakeholders, including employees, customers, investors, and civil society. ESG performance is increasingly becoming a criterion for selection and/or exclusion for investors and end consumers, as well as a key factor in attracting talent.
Investment firms, on the other hand, tend to focus on joining specific initiatives (such as France Invest, UNPRI, CDP, etc.) and prioritize compliance with French and European regulations. While some funds, primarily publicly traded ones, use labeling, the proportion remains low compared to companies. The priority given to alignment with the regulatory framework rather than labeling reflects the need for investment firms to agree on a common reference framework at the European Union level to harmonize practices regarding ESG performance monitoring and communication.
Between generalist labels, thematic or sector-specific labels and various certifications: how do you make the right choice? What selection strategy should be adopted in a world of uneven requirements (green share, sectoral exclusion criteria, points-based scales, etc.)?
Charlotte Allard
Indeed, there is a multitude of labels and certifications with various applications. Some are generalist (like B Corp, for instance), while others are thematic (e.g., Great Place to Work), but they may apply specifically to funds or to their investments. Others cover only specific aspects of ESG, such as the environment, and are applicable to specific investment vehicles, like the Greenfin or LuxFLAG Environment labels.
Before choosing a label or certification, it’s essential to understand your objectives: what are the ESG issues that matter most to you? Which themes or sectors do you want to prioritize? Does the chosen label need to have international recognition? Answering these questions helps to target labels that align best with your priorities and align with your values and specific ESG goals.
While some labels are more holistic than others, it’s essential to remember that the perfect label doesn’t exist. As an alternative, the status of a “Société à Mission,” introduced by the PACTE law in 2019, could be considered the “ultimate” label for certain companies or investment firms.
Giorgia Davidovic
The increasing complexity of ESG topics and the proliferation of ESG practices have accelerated the creation of sector-specific, thematic, and generalist labels and certifications covering the ESG issues faced by companies. For example, companies facing all forms of discrimination, especially during recruitment, may use the Diversity label. Concerning supply chains, the “Relations Fournisseurs et Achats Responsables” (Supplier Relations and Responsible Procurement) label distinguishes companies with ESG-aligned procurement practices. Lastly, the ISO 26030 label provides a framework for ESG best practices throughout the food supply chain. However, the level of rigor and labeling criteria vary significantly from one label to another: some are more focused on practices and resource requirements (e.g., EcoVadis), while others rely on results-based requirements (e.g., Ecocert certifications).
For investment firms, labeling is far from becoming the norm, despite the increasing number of labels. Except for certain asset classes for which specific labels exist, such as real estate with the ISR label, investment firms predominantly prioritize alignment with the regulatory framework.
Therefore, it’s up to each entity to determine which label best addresses its ESG challenges while taking into account the expectations of stakeholders. It’s relevant to consider certain criteria in their selection, such as the recognition and legitimacy of the label (especially its longevity), the scope that suits their needs and ESG strategy, as well as the independence of label attribution and the monitoring regularity.
With the multiplicity of labels and the complexity of the relating deciphering complexity, doesn’t the market end up clinging to the regulatory framework, as evidenced by the increased interest in fundraising for Article 8 and 9 funds?
Charlotte Allard
The proliferation of ESG labels for funds and their complexity can indeed create some confusion in the market. In this context, investors may turn to the regulatory framework to navigate and identify financial products that meet specific regulatory criteria.
The increased interest in funds falling under Articles 8 and 9 can be explained by the fact that these products are more easily recognized as sustainable financial products, especially for Article 9 funds, and investors seem to perceive a certain alignment between declared ESG objectives and investment strategies.
However, it’s important to note that the SFDR (Sustainable Finance Disclosure Regulation) classification, sometimes wrongly used as a label, currently relies only on a declarative transparency principle, unlike certain labels that undergo a very strict verification process.
It’s also important to note that other funds and products not falling under Articles 8 and 9 are not necessarily devoid of ESG approaches. Some funds may choose not to fit into these regulatory categories for various reasons but can still incorporate ESG criteria into their investment process.
Ultimately, labels could be one way to gain clarity, particularly for Article 8 funds, which exhibit highly heterogeneous levels of ambition.
Giorgia Davidovic
For a better understanding of market trends, it’s crucial to distinguish companies and investment firms. European regulations for companies, currently NFDR (Non-Financial Reporting Directive) and soon CSRD (Corporate Sustainability Reporting Directive), apply to a relatively small portion of the market (10,000 companies under NFDR and 50,000 under CSRD) because their mandatory nature vary according to several parameters such as size and revenue. Furthermore, these regulations require disclosure but do not necessarily enforce ESG compliance. As a result, companies seek to differentiate themselves and highlight their ESG initiatives through labels and certifications, particularly sector-specific and thematic ones.
On the other hand, investment firms prioritize compliance with French and European regulatory frameworks, especially through the SFDR classification of their funds, which allows to acquire a certain legitimacy and recognition for their ESG maturity. The SFDR classification is often considered as a “proxy label” by investors, even though it isn’t one in practice. Therefore, the prevalence of compliance with regulations weakens the role and use of labels in the financial domain.
Can green finance labels be a way of guarding against the risk of greenwashing?
Charlotte Allard
Yes, green finance labels can be an effective way to guard against greenwashing, provided that they are based on strict standards and well-defined criteria, undergo independent verification processes by neutral and qualified third parties, and are transparent in their labeling procedures.
They contribute to give investors and stakeholders greater confidence in genuinely sustainable initiatives and products. Investors and stakeholders must, therefore, pay attention to the reputation and recognition of the labels they rely on.
From the perspective of individual investors, a survey conducted by OpinionWay for the AMF (Autorité des marchés financiers) in July 2023, titled ‘French People and Responsible Investments’, shows that French investors support sustainable investment. However, while the majority of them expresses interest, many hesitate to invest due to the complexity of sustainable finance concepts, perceived as too jargon-heavy, and concerns that this complexity may hide a risk of greenwashing. Labels such as ISR (Sustainable and Responsible Investment) and Greenfin are still relatively unknown to the general public (69% of French people not being familiar with either).
Giorgia Davidovic
The labels of sustainable finance are still underutilized today, and the associated labeling criteria are relatively lenient and poorly controlled, making them not always effective in guarding against greenwashing risks. Public denunciations in the media and research publications assert that a certain number of certified funds do not adhere to the labeling eligibility criteria, particularly by investing in companies directly involved in fossil fuel or aviation operations. Furthermore, as sustainable finance labels are relatively new and not yet fully matured, they can create regulatory gray areas. Therefore, it is necessary to remain vigilant regarding sustainable finance labels, as they do not always provide sufficient guarantees regarding the adherence to ESG criteria for these investments.
Aren’t labeling and certification processes, which require substantial human and financial resources, likely to favor large management companies to the detriment of smaller ones?
Charlotte Allard
Yes, it is true that the certification and labeling processes can demand significant human and financial resources, potentially favoring large management companies at the expense of smaller ones. This can occur for several reasons:
High costs that are sometimes associated with applying for and maintaining a label (regular recertifications, etc.). Audit, verification, and monitoring fees can be substantial, making it challenging for small businesses to access these labels.
The certification and labeling processes can be complex and require significant human resources to collect, analyze, and report the necessary data. Management companies with dedicated ESG teams may be in a more favorable position to successfully complete these projects.
To address these inequalities, some certification and labeling organizations have taken these factors into account and have made their labeling processes more accessible and proportional, whether in terms of costs, data requirements, or simplified procedures, specifically tailored to smaller businesses.
Additionally, it is advisable not to hesitate in seeking assistance, whenever possible, from consultants whose expertise can save a significant amount of time, reduce the workload for teams, and minimize potential errors.
Giorgia Davidovic
As mentioned earlier, the overall trend in the financial market is not towards labeling: institutional investors prioritize classifying their funds according to SFDR regulations, and management companies focus on implementing good ESG practices related to investment selection criteria, exclusion lists, methodologies, and consideration of ESG risks and opportunities. Consequently, smaller management companies are not necessarily disadvantaged. Their primary challenge is often the lack of internal expertise and training necessary to understand and implement complex and constantly evolving regulations.