Staying ahead of the curve – ESG Oversight and Assurance

by Matthew Querée, Head of ESG, INDOS Financial

Introduction

Environmental, Social and Governance (ESG) are three words which conjure an extensive range of interpretations across investors, regulators, governments and investment managers.

While many articles look to define ESG, its purpose within the investment sector and its wider impact on environmental protection, societal issues and corporate governance, this piece will simply acknowledge that ESG is now (and for many has always been) a fundamental criterium in the investment decision making process and will continue to gain prominence.

Regulators start to show their mettle

In May 2018, the European Commission announced a set of measures and actions to help bring about its plan on sustainable finance. For many, this commitment by a major body alongside the UN’s agreed sustainability goals firmly illustrate the shift towards ESG within the financial sector.

Included within these EU measures are:

ESG Taxonomy – The creation of an ESG taxonomy to establish clear parameters and definitions around what is considered to be “green” in terms of investment;

A taxonomy will assist asset managers when making sustainable investments. However, asset managers and investors still face many challenges when making determinations about what constitutes green, particularly when analysing large multi-faceted companies who may have a plethora of complex structures or supply chains which are not easily dissectible from a taxonomy perspective. Needless to say, the work required is substantial and delicate. With EU regulators making a push on ESG, it is something firms need to rapidly acquaint themselves with.

Disclosure Obligations – Proposed new regulations that will require institutional investors and asset managers to demonstrate how they are integrating ESG into their investment risk analysis and decision-making process.

This places a direct onus on institutional investors and the asset managers who are investing their funds to demonstrate how ESG is factored into their decision-making processes. As investor ESG sentiment grows alongside increasing regulation encouraging greater sustainable and ethical investing, the importance of clear, transparent reporting on ESG becomes even more paramount.

Benchmarking – Benchmarks are set to be introduced to provide investors with a comparative indicator identifying carbon footprints across their different portfolios.

Elsewhere, the UK government has proposed legislation requiring pension scheme trustees  to consider ESG – as part of their fiduciary obligations – during their investment decision making and capital allocation processes. Furthermore, proposed measures by the Financial Conduct Authority to require financial services firms to publicly disclose how they manage climate financial risk have also been announced and are under consultation.

The end of green-washing and window dressing

By strengthening ESG transparency, reporting and accountability at asset managers and large investors, the ease at which some organisations have been able to green-wash their portfolios (i.e. give the appearance of adopting ESG compliance without actually doing so in order to falsely attract investors) will recede.  

In addition to regulation, there is a continuing shift in attitudes towards investing as the transfer of wealth from the Baby boomer generation to Generation X and Millennials accelerates. Many of these younger investors are more conscientious about where their returns come from, which in turn is prompting a shift towards ESG mandates. As pension funds seek new beneficiaries, they too must adapt to meet the investment needs of a more ethically / morally conscious investor base who will provide funding for the next generation of pension funds.

Staying ahead of the curve – ESG Oversight and Assurance

ESG has been thrust into the spotlight, having previously existed in the shadows of bespoke funds and niche investments. This has led some investment managers to ramp up their presence within the space to ensure they can benefit from the momentum of the ESG movement.

ESG adoption does require managers to differentiate themselves from the competition. One way this could be achieved would be through engaging an independent, conflict free service provider who can review, monitor and report to fund managers and their investors confirming that ESG mandates are being properly followed and adhered to.