IPE: investors grapple with sustainability in short selling strategies

The recent move by the EU to exclude derivatives from sustainable strategies has focused attention on the role of short selling in promoting lower carbon emissions. The dilemma is having a long-term policy aligned with recognized sustainability standards while the emissions exposure from some of the most successful current sources of returns remains obscure.

That challenge is coming to light for hedge funds and their clients given the recent appreciation of hydrocarbons. As one fiduciary manager admits, despite being a member of the Institutional Investment Group on Climate Change and having announced a Net-Zero Carbon policy, “we don’t have a lot of [carbon] data available on our diversifying strategies”. The manager is parking the problem by beginning the journey of reporting greenhouse gas emissions in its long-only equities portfolio. For some hedge funds, the problem may be closer to hand and harder to park.

On 6 April, the European Commission published its long-awaited level-2 regulatory technical standards (RTS) for the Sustainable Finance Disclosure Regulations (SFDR). These are the rules intended to direct European investments towards sustainable economic activities. Section 33 of the latest guidance bans all derivatives from inclusion in funds’ reports on their level of exposure to sustainable economic activities. Derivatives must, however, be included in total economic exposure.

Hedge funds not intending to carry a green label in the EU will be unfazed by this requirement, which effectively says derivatives are not sustainable investments. There are other less prescriptive jurisdictions. Switzerland, for example, has no explicit legal basis for disclosure of climate indicators even in long-only portfolios. But that is all cold comfort to hedge funds or absolute return managers with substantial assets under management from EU pension schemes keen to evidence their ESG credentials.

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