Challenges and opportunities in ESG investing

Was 2020 the year ESG investing became truly mainstream? Peter Christmas, director, client management, NatWest Trustee and Depositary Services (TDS) thinks so. While hosting a recent webinar on sustainable and responsible investment, Christmas suggested that growing evidence of the risks posed by climate change, along with pressure from investors and regulators, has encouraged more urgent discussion and consideration of this subject within the financial services industry. In the meantime, work has continued around regulation and the data challenges for fund managers, investors and corporates.

Chris Day, assistant director, funds regulation and governance, at NatWest TDS, described the rapidly evolving regulatory environment. He highlighted the increasing numbers of firms that have signed up to the UN’s Principles for Responsible Investment (UNPRI) and/or now report in line with recommendations from the Task Force on Climate-Related Financial Disclosures (TCFD). In the UK, TCFD-aligned climate disclosures will be mandatory for many firms across the UK by 2025.

The International Organisation of Securities Commission (IOSCO) is also working on new global sustainability disclosure standards. Meanwhile, the EU’s Sustainable Finance Disclosure Regulation (SFDR) will come into force in stages by January 2022, and ESG elements are being added to other regulations, including the Alternative Investment Fund Managers Directive (AIFMD), the Undertakings for the Collective Investment in Transferable Securities (UCITS) and MiFID II (the Markets in Financial Instruments Directive).

The UK Financial Conduct Authority (FCA) has set out principles it will use to assess applications for sustainable investment products. There has been a significant increase in the use of eco-labels for green financial products in Europe, through schemes including the Greenfin Label in France, FNG-Siegel in Germany, Austria and Switzerland, and the LuxFLAG in Luxembourg. More are expected to launch in 2021.

“The question is, are we at the tipping point for sustainable investing?” Day asked. “There are increasing signs that may be the case… [ESG] is now a mainstream issue that asset managers need to be aware of and take account of in their product design.”

Ben Sanderson, executive director, fund management, at Federated Hermes, argued that one key reason for this is that ESG is no longer viewed by investors as being defined by exclusions and risk avoidance, but instead as a source of out-performance.

The potential for the wide range of regulatory activity to cause confusion does not appear to be suppressing investors’ appetites, but there is a clear need to help investors understand the issues and opportunities connected to ESG investing.

Leslie Gent, managing director and head of responsible investing at Coutts & Co, said the bank is focusing on investor education and communication to help investors gain a better understanding of the subject. She agreed that a lack of consistency in the way corporates report on ESG is a problem, but suggested that the solution will be based on increased transparency.
 

“ESG is now a mainstream issue that asset managers need to be aware of and take account of in their product design”

Chris Day, assistant director of regulatory risk, NatWest Trustee and Depositary Services
 

“That means being transparent around the fact that there are data issues,” she explained. “My key message would be: ‘Don’t get caught up in being perfect. You have to start somewhere.’”

Eoin Walshe, UK ESG data and analytics lead at PwC, described the data challenges associated with ESG investing.

“Because of the novel nature of this type of information, the way that we’re capturing it, the way that we’re defining it, varies quite significantly,” he explained.

Walshe added that the resulting inconsistency is enabling deliberate greenwashing – where “you can go and find the data that backs what you’re already doing” – as well as accidental greenwashing. “One might be making the best effort possible to integrate the ESG factors, but by using surface-level metrics and scores, not articulating the underlying impact effectively,” he said.

NatWest TDS has created an ESG investing support tool that will enable independent accreditation of funds by moving away from the current inconsistent methods used to assess ESG performance to a more data-driven approach. Walshe said it will allow users “to understand the fundamental components and data footprint of this company… to enable a more contextual and granular analysis of ESG fundamentals” and construct meaningful benchmarks.

The next step, Walshe suggested, will be to expand the coverage and timeliness of the data through analysis of non-traditional sources such as corporate news, patent filings and corporates’ wider digital footprints.

In this way, Walshe explained, fund management can move beyond a screening-based approach to one capable of capturing new ESG factors as they emerge – one that is “focused on the future and understanding how we get to the ultimate objectives that we need to achieve, in terms of decarbonisation, inclusion and other factors”.

In the expectation of further progress being made, Christmas asked the webinar participants to what extent they expected ESG investing to be integrated with mainstream investment in three to five years’ time.

“I’m hoping that it’s co-mingled,” said Gent. “That’s kind of the whole point of it, isn’t it? So investment managers don’t just focus on the financial measures but also on these very important non-financial measures. My bet is, it’s just part of the BAU [business as usual] of how you manage investments.”

Sanderson took a similar view, with the caveat that there must be a role for impact investing that focuses on a particular set of ESG outcomes over and above broader ESG integration on “employment outcomes, or charitable outcomes, or social equality outcomes”.

The drive towards ESG is an international trend, but there could be an opportunity for the UK funds management industry to take the lead in this field, said Gent. “In Europe and in the UK, we’ve had a big regulatory push around ESG issues,” she explained.

“A lot of the asset-management players have woken up to the fact that it isn’t just about regulation, this is about domestic demand and meeting the demand from investors. I think the UK has a real opportunity here to lead.”