Mandatory disclosure cuts investors' fossil fuel exposure

IFR 2367 - 23 Jan 2021 - 29 Jan 2021
3 min read
Tessa Walsh

Institutional investors forced to give detailed climate-related information by mandatory disclosure rules have significantly less exposure to the fossil fuel sector than those disclosing on a voluntary basis, according to a report by Banque de France that analysed the impact of a groundbreaking French law.

France introduced the Energy Transition and Green Growth law, (Transition Energetique et Croissance Verte law or TECV) following the 2015 Paris Agreement on climate change. The law requires institutional investors to report annually on their climate-related exposure and climate change mitigation policies.

Investors registered in France who had to disclose their funding of high-emitting industries had 39% less exposure to the fossil fuel sector by September 2019 relative to those that were subject to voluntary disclosure, according to the report.

“The effect of the mandatory climate-related disclosure on investments into these carbon-intensive companies is strongly significant, both statistically and economically,” the report said.

The TECV law was the first in the world to make disclosure mandatory, and is widely credited for establishing France’s leadership position in ESG. It was implemented in January 2016 to make institutional investors, including insurance companies, pension funds, asset managers and mutual funds, aware of their investment emissions and align investments to a low carbon economy

The law made it possible to compare French institutional investors’ holdings with other institutions that are subject only to voluntary disclosure, including French banks and financial institutions in other eurozone countries.

The report said that the 39% reduction stopped an estimated €28bn from flowing into the fossil fuel sector from French investors. With eurozone investors holding approximately €600bn of fossil fuel exposure (according to Banque de France estimates), a similar reduction across the single-currency region would be very significant.

"If we see a similar effect in the euro area it's a big deal," said Benoit Nguyen, a senior research economist at Banque de France and one of the authors of the report. "The takeaway of our paper is that there is a value added by regulation, but the main effect will certainly come from disinvestment."

The issue of disclosure is continuing to climb regulators’ and banks’ agendas, as pressure grows on banks to disclose the carbon footprint of their portfolios.

More mandatory disclosure is expected as the EU’s Green Deal is implemented, and the EU’s Non-Financial Reporting Directive integrates the recommendations of the Task Force on Climate-related Financial Disclosure at a European level.

“While voluntary moves for enhanced carbon disclosure are welcome, more stringent regulations on carbon reporting are of the essence to effectively speed up the alignment of finance with transition needs,” the report said.

France ahead

Banque de France is also a leader in climate finance and is running its first stress test on climate risk this year. It said on Monday that by 2024 it will exit from coal entirely and limit exposure to gas and oil in its €22bn investment portfolio.

Climate-related disclosure is already increasing. The European Commission published guidelines in June 2019 on reporting climate-related information, and launched a public consultation in April 2020 on its renewed sustainable finance strategy, which it will present in early 2021.

Increased mandatory disclosure and further regulation is likely to accelerate global divestment from carbon-intensive sectors and could create more stranded assets as the investor base continues to shrink.