sustainability – EU action plan.
Lombard Odier Group attaches particular importance to analysing the opportunities and impacts of the EU Action Plan on Sustainable Finance (EU Action Plan) and of any other relevant regulation (i.e. specific local/national legislation) to ensure a comprehensive understanding of sustainability challenges.
what is the EU action plan on sustainable finance?
The EU Action Plan1 is part of the EU Commission's broader efforts to connect finance with the specific needs of the global economy for the benefit of the planet and our society. Specifically, this Action Plan aims to:
- reorient capital flows towards sustainable investments in order to achieve sustainable and inclusive growth;
- manage financial risks stemming from climate change, resource depletion, environmental degradation, and social issues; and
- foster transparency and long-termism in financial and economic activity.
what is the sustainable finance disclosure regulation (SFDR)2?
In a nutshell: The Sustainable Finance Disclosure Regulation (SFDR) is a European regulation introduced to improve transparency in the market for sustainable investment products and services, to prevent greenwashing, and to increase transparency around sustainability claims made by financial market participants. It imposes comprehensive sustainability disclosure requirements at entity and at product level, such as the classification of financial products according to their level of sustainability ambition. The main provisions of the SFDR became applicable in March 2021.
Entity level: Transparency on the integration of sustainability risks
What are sustainability risks?
Sustainability risk means an environmental, social, or governance event or condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment.
Identification of sustainability risks
There are various sources of sustainability risks that may impact the financial product and/or service. Not all risks may be relevant to all investments.
Non-exhaustive list of sustainability risks:
Environmental and climate risks: Environmental degradation and climate change are sources of structural alterations that affect economic activity and, in turn, the financial system. Climate-related and environmental risks are commonly understood to comprise two main risk drivers:
Physical risk refers to the financial impact on a company of a changing climate – including more frequent extreme weather events and gradual changes in climate – as well as of environmental degradation such as air, water, and land pollution; water stress; biodiversity loss; and deforestation.
Transition risk refers to a company’s financial loss that can result, directly or indirectly, from the process of adjustment towards a lower-carbon and more environmentally sustainable economy. This could be triggered, for example, by a relatively abrupt adoption of climate and environmental policies, technological progress, or changes in market sentiment and preferences.
Social risk refers to any negative financial impact on a company stemming from the current or prospective impacts of social factors – such as poor labour standards, human rights violations, harm to public health, data privacy breaches, or increased inequalities – on its counterparties or invested assets.
Governance risk refers to any negative financial impact on a company stemming from the current or prospective impacts of governance factors, such as an inadequate governance framework, on its counterparties or invested assets. Governance risk may for example arise from a lack of accountability and transparency of the board, or from the unequal treatment of shareholders and stakeholders.
Bearing in mind these very real risks as well as our obligations under SFDR, Lombard Odier is convinced that proper integration of sustainability risks into our investment decision-making process will mitigate the impact of such risks on the value of our investments, and will help enhance long-term risk-adjusted returns for our clients.
integration of sustainability risks
We strongly believe that sustainable value creation for our clients starts with a robust and sound product governance framework, in which the integration of sustainability risks plays a major role. Hence, Lombard Odier is committed to incorporating sustainability risks into the design, selection, promotion, and distribution of its financial products and services.
This integration and management of sustainability risks in our investment decisions and advice is achieved in part by revising and applying in-house policies that prohibit and/or restrict investments in the following sectors: controversial weapons, essential food commodities, tobacco, coal, unconventional oil & gas – as well as in cases constituting severe breaches of the UN Global Compact Principles.
In addition to the exclusion and restriction policies, Lombard Odier’s sustainable investment framework screens and monitors companies' business practices in relation to their broad ecosystem of stakeholders, and considers the improvement of these practices through the evolution of metrics from the mere consciousness of an issue, to action, and finally mitigation of a sustainability risk.
We have developed a proprietary ESG materiality heatmap and rating methodology that allows us to hone in on the environmental, social, and governance aspects that are truly important to a given company. This framework comprises 14 categories that reflect the potential ESG opportunities and risks across a company’s value chain: these include the upstream risks predominantly related to supply chain or natural resource usage; operational risks directly related to a company’s direct production and operational processes; and downstream risks related to the potential negative impact of products and services sold.
For Lombard Odier, integrating sustainability risks is crucial to the investment decision making process. It amplifies the identification of any investment-related risk, enabling us to make holistic and resilient investment decisions about our investment universe and for our clients’ portfolios.
consideration of principal adverse impacts on sustainability factors
What are principal adverse impacts (PAIs)?
Principal adverse impacts on sustainability factors are those impacts of investment decisions and advice that result in negative effects on environmental, social, and employee matters; respect for human rights; as well as on anti‐corruption and anti‐bribery matters.
What are sustainability factors?
Environmental, social, or governance matters that may have a positive or negative impact on the financial performance or solvency of an entity, sovereign, or individual.
Lombard Odier considers the principal adverse impacts of investment decisions and advice on sustainability factors in its discretionary portfolio management and advisory services, where relevant, as follows:
- Principal adverse sustainability indicator number 14 in Table 1, Annex I of SFDR Level 2, related to the exposure to controversial weapons (anti-personnel mines, cluster munitions, chemical weapons, and biological weapons), is considered through our investment exclusion rules.
- Principal adverse sustainability indicator number 10 in Table 1, Annex I of SFDR Level 2, related to the violations of UN Global Compact principles and Organisation for Economic Cooperation and Development (OECD) Guidelines for Multinational Enterprises, is implemented by restricting investments in the severe controversies described below, and is also included in our proprietary ESG materiality rating method via a rating penalty.
- Other principal adverse sustainability indicators in Table 1, Annex I of SFDR Level 2 are considered within the Lombard Odier ESG materiality rating methodology. For each issuer, the weighting of these principal adverse sustainability indicators is set according to the exposure of the relevant industry to the sustainability challenges, with this exposure being defined by the investment manager’s in-house materiality framework.
- Other principal adverse sustainability indicators in Table 2 (environmental) and Table 3 (social), Annex I of SFDR Level 2 are embedded in the investment manager’s ESG materiality rating when available.
Furthermore, a selection of material indicators of adverse impact is considered in the analysis carried out by Lombard Odier, in order to qualify economic activities as sustainable investments under our Lombard Odier Alignment Framework. The way that principal adverse sustainability indicators are taken into consideration may change over time depending on a number of factors, including the changing composition of the portfolio, market conditions, data coverage, and developments in global sustainability analysis.
lombard odier alignment framework.
Lombard Odier uses a pass/fail approach to define whether or not a given investment, defined at the company level, is considered a ‘sustainable investment’.
Lombard Odier classifies companies as belonging to one of three categories: a Sustainable Investment, Grey Investment, or Red Investment.
To ‘pass’ as a Sustainable Investment, a company must meet the criteria detailed below.
1) Passing our contribution test requires a company to either:
a. Have at least 30% environmentally sustainable activities, understood to include
(i) activities that are eligible under at least one of the six environmental objectives recognised by the EU Taxonomy and which meet the contribution technical screening criteria as included or expected to be included in the EU Taxonomy; or
(ii) activities that are eligible under at least one of the six environmental objectives recognised by the EU Taxonomy and which meet the contribution technical screening criteria as defined by Lombard Odier; or
(iii) specific transitioning or enabling activities not included in the EU Taxonomy, but which have been mapped to one or several of the six environmental objectives recognised by the EU Taxonomy, and which meet the technical screening criteria as defined by Lombard Odier.
or
b. Demonstrate significant alignment of capex3 (or equivalent industry-relevant investment metric) with EU Taxonomy or with Lombard Odier’s Contribution Technical Screening criteria that supports a clearly articulated and ambitious transition strategy with targets aligned to one of the six environmental objectives.
A company’s exposure to relevant activities and/or transition strategy can be established using either:
a. The company’s own EU Taxonomy-related disclosures; or
b. Lombard Odier’s documented assessment of the company and its activities, which can be performed either systematically and quantitatively, or qualitatively, fundamentally, and based on research.
2) Passing our Do No Significant Harm (DNSH) test requires a company to either:
a. Have at most 5% revenue exposure to “red” activities, classified by Lombard Odier as inherently harmful in nature, including those activities related to thermal coal mining, coal-based power generation, and oil extraction or refining, along with other select activities;
b. Pass our absolute or best-in-class scoring against a sub-set of PAIs selected according to the company’s activity exposure; or
c. Meet additional criteria: although the above criteria constitute the minimum criteria we apply, in its assessment of companies involved in specific activities, Lombard Odier may use other criteria as an additional safeguard.
3) Passing our Good Governance Test requires a company to either:
a. Pass our absolute or best-in-class scoring against a sub-set of PAIs selected according to the company’s activity exposure; or
b. Meet additional criteria: although the above criteria constitute the minimum criteria we apply, in its assessment of companies involved in specific activities, Lombard Odier may use other criteria as an additional safeguard.
Lombard Odier Group, signatory of the United Nations Principles for Responsible Banking
At the end of 2020, Lombard Odier Group became an official Signatory of the UN Principles for Responsible Banking. These principles set out the banking industry’s role and responsibility in shaping a sustainable future and in aligning the banking sector with the objectives of the UN Sustainable development goals (SDGs).
remuneration policy
Lombard Odier’s remuneration policy and related practices aim at protecting the interests of Lombard Odier’s customers, as well as its long-term financial sustainability and compliance with regulatory obligations. In this context, Lombard Odier has established, implemented, and maintains a remuneration policy, which promotes effective risk management and does not induce excessive risk-taking. The determination of variable remuneration integrates measures that can include the consideration of sustainability risks based on the type of products or services provided to external customers.
what is the eu taxonomy regulation?4
In a nutshell: The Taxonomy Regulation is a European regulation introduced to establish a framework to facilitate sustainable investment. It aims to create a ‘green list’ of environmentally sustainable economic activities.
The Taxonomy was conceived as an investment tool that should facilitate sustainable investment by identifying and defining, through the use of science-based criteria, activities that qualify as sustainable.
what are the MIFID II ESG amendments?
In a nutshell: The MIFID II ESG amendments require firms to:
• Obtain information about clients’ sustainability preferences as part of their investment objectives
• Illustrate in suitability reports how services provided meet clients’ expressed sustainability preferences
• Describe how sustainability factors are taken into account in the investment advice process.
1 EU Commission Action Plan: Financing Sustainable Growth, 8 March 2018.
2 Regulation (EU) 2019/2088 of the European Parliament and of the Council of 27 November 2019 on sustainability-related disclosures in the financial services sector (SFDR)
3 Capital expenditures (capex) are funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment. Capex is often used to undertake new projects or investments by a company.
4 Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088 (EU Taxonomy)
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