03 May 2022
How should fund managers approach their net-zero targets?
Looking to 2030, Bradley Davidson, ESG Lead at RBS International, examines how alternative fund managers set out on their net-zero journey
Looking to 2030, Bradley Davidson, ESG [environmental, social and governance] Lead at RBS International, examines how alternative fund managers set out on their net-zero journey.
The 2030 targets emerge from the adoption and implementation of the 2015 Paris Agreement, setting out a legally binding international treaty to limit global warming well below 2°C above pre-industrial levels. COP26 has refocused the question on targets and time frames. For instance, the Net Zero Asset Managers initiative, with 220 signatories, has a 10-point commitment that includes “interim targets for 2030, consistent with a fair share of the 50% global reduction in CO2 identified as a requirement in the IPCC special report on global warming of 1.5°C”.
My colleague Caroline Haas, Head of Climate and ESG Capital Markets at NatWest, is optimistic about such moves: “This makes people more accountable because the people that are negotiating now are the ones that have to answer for it and implement the respective changes.”
For asset managers, it is ambitious. We have to accelerate, mobilising more capital for renewable energy. Meanwhile, the invasion of Ukraine sits front and centre as we start to understand why the dependency that we’ve had on fossil fuels is not sustainable.
Meeting and anticipating regulation
From a regulatory point of view, funds won’t gain a competitive advantage over peers by aiming to meet ESG regulation. The policy development process is often slower than the shift in preferences from investors and other stakeholders. Therefore funds should not be waiting for regulation to drive their ESG strategy.
It’s near impossible to predict the exact actions of any regulator but embedding voluntary frameworks such as the Task Force on Climate-related Financial Disclosures (TCFD), before they’re enshrined into law, will help validate and safeguard strategies.
There are three main types of ESG regulation developing for financial institutions: disclosures, marketing and climate-risk management.
Thinking about disclosures, as of 6 April 2022, the UK became the first G20 country to mandate climate-related financial disclosures when TCFD became a requirement for the largest UK companies. The European Commission has aligned with the TCFD framework, mandating disclosures under the Corporate Sustainability Reporting Directive. Those institutions that have previously taken steps to embed TCFD reporting will have gained an advantage compared with those not yet implementing climate-related disclosures.
“For those with a commitment to net zero, getting on top of the data challenge is crucial to be able to demonstrate a credible approach. At present, data on companies’ emissions is not always easily obtainable or comparable”
Adam Jacobs-Dean, MD, Global Head of Markets, Governance and Innovation, AIMA
As for marketing, ‘greenwashing’ is a significant concern for regulators as ESG continues to attract large investment volumes. The Sustainable Finance Disclosure Regulation (SFDR) requires funds marketed in the EU to indicate the level to which ESG is integrated at both an entity and product level. In Jersey, the Financial Services Commission has published new disclosure requirements to define “sustainable investments” for funds operating in the jurisdiction. As greenwashing concerns rise, we can expect further developments from regulators, making it imperative for funds to clearly document how a green or sustainable label has been defined.
Regarding risk management, regulators appear to be starting with credit institutions, but there is a clear trend of regulation on the management of climate risk. Followed closely by the CSSF – the Luxembourg regulator – as it introduced new legislation in 2021, recognising the risk of climate change to banks. Authorised fund managers (AFMs) may face similar calls to demonstrate the management of ESG risks as regulators look to protect investors.
Adam Jacobs-Dean is Managing Director, Global Head of Markets, Governance and Innovation at the Alternative Investment Management Association (AIMA). He says:
“For those with a commitment to net zero, getting on top of the data challenge is crucial to be able to demonstrate a credible approach. At present, data on companies’ emissions is not always easily obtainable or comparable, and it gets even more challenging for investments outside the listed corporate space. Another important element is a well-considered approach to stewardship to create the necessary pressure on corporates to reduce their emissions. For some, that might mean direct engagement with companies, but there are also various industry initiatives that managers can sign up to which help move the dial.”
Many of these initiatives exist to support focus on targets. Certified B Corporation or commitments to industry collectives, such as the Net Zero Asset Managers initiative, can provide a strong market signal to cut through a crowded market of ESG messaging.
As Caroline Haas explains, membership can be seen as a nod to the market to show that a manager is putting sustainability high up the corporate agenda: “Certified B is about a company wanting to show how ESG friendly or sustainable it is, both from operations and the human resources development side, and how it treats its supply and its supply chain expectations.”
She adds: “It’s voluntary, but a company can show by getting this certification that it has created these respective checks and balances in its business to ensure there is sustainability.”
All of these initiatives make things more transparent and enhance accountability. Ratings agencies such as Sustainalytics, MSCI and ISS take publicly available information, map it against entities and provide investors with that ESG information. There are around 150 of these on the market, but they are difficult to compare because they have slightly different technologies and methodologies.
Investors tend to create their own investor scorecard, with different KPIs (key performance indicators) from different agencies that feed into their system and create their scores. And from those scores, they can compare what, for example, the energy companies look like. As a result, they feel more in control because they know what has fed into those numbers.
COP26 has intensified investor focus on ESG
Looking back over the past 18 – 24 months, a qualitative ESG statement may have been enough to appease specialist investors with a focus on sustainability. Today, we find ourselves in a new market and expectations from investors have dramatically increased regarding ESG. Investors understand that the intelligent management of ESG factors may not only protect investments through active risk management but also identify new opportunities.
Following the launch in November of the SBTi (Science Based Target initiative) guidance for the private equity sector, providing a grounding for alternative investment asset classes, we have seen funds develop and validate targets that align with the Paris Agreement. It may be too early to say, but the positive market response indicates a first-mover advantage.
Looking ahead to COP27, there will be a continued call for the acceleration of action both from member states and the companies operating within them.
Haas says: “There were some very ambitious targets set at COP26 and people will want to see progress a year later. They will want to see how asset owners and managers have started to change their behaviour and how this is affecting the ambition of industry or the companies that they invest in.
“I also think there will be a focus on energy, given the situation in Ukraine, as we need to get more renewables on stream and break the dependencies on fossil fuels, making countries more self-sufficient while reducing the cost to households.”
The UK Budget due out on 17 November is expected to bring significant fiscal tightening in a bid to restore the government’s financial credibility
As consolidation in the alternative fund market continues, general partners are looking for other means to fund their commitments.
In this edition the FCA’s new Consumer Duty, an update on LTAF, ESG investing, ‘side pocket’ proposals and regulatory horizon scanning.