No longer a niche
14 Feb 2020
Industry experts discuss how ESG is becoming more prominent and has moved from niche to mainstream in recent years, however, challenges lurk ahead and there is still much work to be done to create a standardised approach
Image: Shutterstock
Known for its luscious beaches, the Great Barrier Reef and the Sydney Opera House, Australia is one of the largest countries in the world.
The country is also well-known for its wildlife, including koalas, crocodiles and kangaroos, but recently it has captured the world’s attention with haunting footage of ferocious and deadly bushfires, which at the time of writing has killed an estimated one billion animals and 23 people, with more still missing .
Vast numbers of mammals, birds, reptiles, insects and other species have been lost to these fires, with some experts suggesting that it may take up to 100 years for the ecosystems the animals depend on to bounce back.
Globally, climate change and other environmental factors are a major issue, and conversations on this topic are leaking into every industry, including financial services.
In the asset servicing industry, market participants are stepping up and are considering – and working on – how to incorporate environmental, social and governance (ESG) into the investment process.
Speaking to Asset Servicing Times’ sister publication last year, Andrew Dyson, ISLA’s CEO, described ESG as an umbrella term for investments that seek positive returns and long-term impact on society, environment and the performance of the business.
Industry experts have observed that the asset servicing industry has become an increasing enabler of ESG but there are many challenges that exist around standardisation and data. For example, while one company may see tobacco as unethical and may choose not to invest in it, another may see guns and weaponry as unethical – but would instead invest in tobacco products – thus making aspects of ESG complex to navigate.
However, the attention that ESG is receiving from the industry means that people are actively working towards improving practices.
Reinforcing this point, Jan Erik Saugestads, CEO of Storebrand Asset Management, says: “Integrating ESG in your investment process means that you look at your investments through a sustainability lens. As an investor, you strive to understand all risks and opportunities in a potential investment also incorporating ESG data. The asset servicing industry plays an important role in this by providing data, technology and legal advice. Clearly this is both the right thing to do and the smart thing to do. Together we play a key role in moving capital in the right direction.”
No longer a niche
Simultaneous with the rest of the world, the concern around the environment is echoed in the asset servicing industry, and it is increasingly becoming a hot topic at conferences, for example. Michael Peters, member of the Eurex executive board, observes that sustainable investing is no longer a niche area; it is going mainstream. In fact, years ago, investors and clients had to be heavily convinced that the integration of ESG in the investment process did not hinder return.
Saugestads explains: “Many believed that any restriction to the investment universe would be negative. Years of experience and several academic studies have proven the myth unfounded. Today, most investors and clients believe that a well-executed integration of ESG data in the investment process can generate excess return. Sustainability provides us with better information on risks and opportunities and makes us better as asset managers.”
ESG can be broken into three different groupings of factors that can be used to measure sustainability and the ethical impact of an investment in a company.
HSBC Securities Services’ senior product manager, market data, Chris Johnson, says that for asset servicing “it is possible to include ESG reporting of investments according to ESG ratings and scores and carbon emission, the validation of negative screening criteria and supporting clients’ engagement and voting”.
Eurex’s Peters identifies that ESG helps when undertaking a comprehensive evaluation or a short- to medium-term prognosis of a company’s success.
He comments: “For this reason, investors are increasingly considering qualitative criteria, alongside the classic quantitative investment criteria such as rate of return, risk and liquidity. In short, this means that capital is being invested to ensure that today’s investment needs are met without endangering future generations.”
Peters also further dispels the claim that ESG can have a negative impact on performance, and says that the development of Eurex’s ESG derivatives proves the opposite.
Eurex reached half a million traded contracts on 12 December 2019, with a nominal value of €7 billion, with 55 percent of the flow coming from end-clients and asset owners, and they have the same performance as their benchmarks; some have even outperformed them, according to Peters.
“These figures not only further demonstrate Eurex’s leading role in this segment, but they also show that the above claim was just a myth,” Peters notes.
A lack of standardisation
While the industry has made progress in tackling the main myths and stigma around ESG, technical challenges still remain.
One of the difficulties with ESG is that different people have different ideas of what ethical investing is, which is just one of the many technical issues that needs to be resolved.
BNY Mellon’s Fraser Priestley, managing director of global risk solutions in Europe, the Middle East and Africa, emphasises that analysing investments against sustainability factors is a key challenge for institutional investors.
“As asset servicers, we hold the information on assets that we can link to ESG rating data, providing a single lens to allow comparison for investors, showing performance alongside ESG scores, and we can monitor for and support post trade ESG compliance and reporting,” Priestley says. Explaining this further, he notes that there are variations in ESG methodologies, frameworks and reporting which can be scarce or inconsistent.
“The lack of standardisation creates difficulties in measuring and comparing non-financial performance, and remains a major hurdle,” Priestley adds.
Additionally, ESG data quality needs to be improved. Saugestads emphasises that there is “significant room to improve the quality of data and make it more forward looking”.
HSBC Securities Services’ Johnson, highlights that one misconception is that ESG data can be used in the same way as financial data.
He comments: “This is not the case. We have established that ESG scores and ratings can vary significantly between providers for the same company.”
According to Johnson, the interpretation of ESG-related information, and the relative importance of items within the broad field of ESG, can be very subjective.
“Rather than being factual measures, the scores and ratings should generally be viewed more as opinion-based evaluations. Therefore ESG data needs to be analysed carefully and understood fully before it is relied upon for investment and reporting purposes”, Johnson explains.
Reshaping the structure
Looking at the future landscape, BNY Mellon’s Priestley observes that the asset servicing industry will “increasingly become an enabler of ESG investment, providing investors with the data, monitoring and post-trade services essential for implementing successful ESG strategies. This includes restriction monitoring, ESG scoring and ESG benchmarking, and potentially ESG performance attribution and measuring the impact of ESG on volatility and risk”.
Similarly, Johnson states: “It is likely that ESG will be integrated across mainstream post-trade reporting once regulatory reporting requirements become prescriptive, and ESG data becomes more standardised”.
“Asset servicers could be expected to offer independent reporting of ESG over that time period.”
Amidst the optimism, however, Erik Saugestads reminds us that to avoid greenwashing we need strong tools to improve transparency and measure the impact of portfolios.
“We already see regulations put pressure on asset managers to document the ESG content and impact of their portfolios,” Staugestads says.
Meanwhile, evidence showing that the industry is responding to ESG demands is outlined by Eurex, for example, which, in response to increasing customer enquiries, listed futures on STOXX® ESG-X, Low Carbon and Climate Impact Indices in February 2019.
Peters notes: “Since our ESG segment has traded more than half a million contracts in a little less than a year, we are very confident that ESG investing will grow further. We are ready to mark the next step in our ESG strategy by expanding our ESG equity index-linked product suite during the first quarter of 2020. With the introduction of derivatives on sustainable versions of various regional and global benchmarks, we will achieve global coverage with our ESG offering.”
“But there are other factors that make us optimistic about the development of sustainable investing. These are driven by societal and demographic changes, increased regulation and government focus, and greater investment conviction. Investor demographics show that the millennials, the generation that is providing new and upcoming investors, have very strong views on sustainability,” Peters adds.
So as we head deeper into 2020, ESG will be at the forefront of mind for many in the industry.
This move from niche to mainstream is expected to become even more prominent in the asset servicing industry over the next five years.
But while there has been much success in this area, industry participants will continue work to overcome the hurdles and work towards a standardised approach and tackle the issues surrounding ESG data.
The country is also well-known for its wildlife, including koalas, crocodiles and kangaroos, but recently it has captured the world’s attention with haunting footage of ferocious and deadly bushfires, which at the time of writing has killed an estimated one billion animals and 23 people, with more still missing .
Vast numbers of mammals, birds, reptiles, insects and other species have been lost to these fires, with some experts suggesting that it may take up to 100 years for the ecosystems the animals depend on to bounce back.
Globally, climate change and other environmental factors are a major issue, and conversations on this topic are leaking into every industry, including financial services.
In the asset servicing industry, market participants are stepping up and are considering – and working on – how to incorporate environmental, social and governance (ESG) into the investment process.
Speaking to Asset Servicing Times’ sister publication last year, Andrew Dyson, ISLA’s CEO, described ESG as an umbrella term for investments that seek positive returns and long-term impact on society, environment and the performance of the business.
Industry experts have observed that the asset servicing industry has become an increasing enabler of ESG but there are many challenges that exist around standardisation and data. For example, while one company may see tobacco as unethical and may choose not to invest in it, another may see guns and weaponry as unethical – but would instead invest in tobacco products – thus making aspects of ESG complex to navigate.
However, the attention that ESG is receiving from the industry means that people are actively working towards improving practices.
Reinforcing this point, Jan Erik Saugestads, CEO of Storebrand Asset Management, says: “Integrating ESG in your investment process means that you look at your investments through a sustainability lens. As an investor, you strive to understand all risks and opportunities in a potential investment also incorporating ESG data. The asset servicing industry plays an important role in this by providing data, technology and legal advice. Clearly this is both the right thing to do and the smart thing to do. Together we play a key role in moving capital in the right direction.”
No longer a niche
Simultaneous with the rest of the world, the concern around the environment is echoed in the asset servicing industry, and it is increasingly becoming a hot topic at conferences, for example. Michael Peters, member of the Eurex executive board, observes that sustainable investing is no longer a niche area; it is going mainstream. In fact, years ago, investors and clients had to be heavily convinced that the integration of ESG in the investment process did not hinder return.
Saugestads explains: “Many believed that any restriction to the investment universe would be negative. Years of experience and several academic studies have proven the myth unfounded. Today, most investors and clients believe that a well-executed integration of ESG data in the investment process can generate excess return. Sustainability provides us with better information on risks and opportunities and makes us better as asset managers.”
ESG can be broken into three different groupings of factors that can be used to measure sustainability and the ethical impact of an investment in a company.
HSBC Securities Services’ senior product manager, market data, Chris Johnson, says that for asset servicing “it is possible to include ESG reporting of investments according to ESG ratings and scores and carbon emission, the validation of negative screening criteria and supporting clients’ engagement and voting”.
Eurex’s Peters identifies that ESG helps when undertaking a comprehensive evaluation or a short- to medium-term prognosis of a company’s success.
He comments: “For this reason, investors are increasingly considering qualitative criteria, alongside the classic quantitative investment criteria such as rate of return, risk and liquidity. In short, this means that capital is being invested to ensure that today’s investment needs are met without endangering future generations.”
Peters also further dispels the claim that ESG can have a negative impact on performance, and says that the development of Eurex’s ESG derivatives proves the opposite.
Eurex reached half a million traded contracts on 12 December 2019, with a nominal value of €7 billion, with 55 percent of the flow coming from end-clients and asset owners, and they have the same performance as their benchmarks; some have even outperformed them, according to Peters.
“These figures not only further demonstrate Eurex’s leading role in this segment, but they also show that the above claim was just a myth,” Peters notes.
A lack of standardisation
While the industry has made progress in tackling the main myths and stigma around ESG, technical challenges still remain.
One of the difficulties with ESG is that different people have different ideas of what ethical investing is, which is just one of the many technical issues that needs to be resolved.
BNY Mellon’s Fraser Priestley, managing director of global risk solutions in Europe, the Middle East and Africa, emphasises that analysing investments against sustainability factors is a key challenge for institutional investors.
“As asset servicers, we hold the information on assets that we can link to ESG rating data, providing a single lens to allow comparison for investors, showing performance alongside ESG scores, and we can monitor for and support post trade ESG compliance and reporting,” Priestley says. Explaining this further, he notes that there are variations in ESG methodologies, frameworks and reporting which can be scarce or inconsistent.
“The lack of standardisation creates difficulties in measuring and comparing non-financial performance, and remains a major hurdle,” Priestley adds.
Additionally, ESG data quality needs to be improved. Saugestads emphasises that there is “significant room to improve the quality of data and make it more forward looking”.
HSBC Securities Services’ Johnson, highlights that one misconception is that ESG data can be used in the same way as financial data.
He comments: “This is not the case. We have established that ESG scores and ratings can vary significantly between providers for the same company.”
According to Johnson, the interpretation of ESG-related information, and the relative importance of items within the broad field of ESG, can be very subjective.
“Rather than being factual measures, the scores and ratings should generally be viewed more as opinion-based evaluations. Therefore ESG data needs to be analysed carefully and understood fully before it is relied upon for investment and reporting purposes”, Johnson explains.
Reshaping the structure
Looking at the future landscape, BNY Mellon’s Priestley observes that the asset servicing industry will “increasingly become an enabler of ESG investment, providing investors with the data, monitoring and post-trade services essential for implementing successful ESG strategies. This includes restriction monitoring, ESG scoring and ESG benchmarking, and potentially ESG performance attribution and measuring the impact of ESG on volatility and risk”.
Similarly, Johnson states: “It is likely that ESG will be integrated across mainstream post-trade reporting once regulatory reporting requirements become prescriptive, and ESG data becomes more standardised”.
“Asset servicers could be expected to offer independent reporting of ESG over that time period.”
Amidst the optimism, however, Erik Saugestads reminds us that to avoid greenwashing we need strong tools to improve transparency and measure the impact of portfolios.
“We already see regulations put pressure on asset managers to document the ESG content and impact of their portfolios,” Staugestads says.
Meanwhile, evidence showing that the industry is responding to ESG demands is outlined by Eurex, for example, which, in response to increasing customer enquiries, listed futures on STOXX® ESG-X, Low Carbon and Climate Impact Indices in February 2019.
Peters notes: “Since our ESG segment has traded more than half a million contracts in a little less than a year, we are very confident that ESG investing will grow further. We are ready to mark the next step in our ESG strategy by expanding our ESG equity index-linked product suite during the first quarter of 2020. With the introduction of derivatives on sustainable versions of various regional and global benchmarks, we will achieve global coverage with our ESG offering.”
“But there are other factors that make us optimistic about the development of sustainable investing. These are driven by societal and demographic changes, increased regulation and government focus, and greater investment conviction. Investor demographics show that the millennials, the generation that is providing new and upcoming investors, have very strong views on sustainability,” Peters adds.
So as we head deeper into 2020, ESG will be at the forefront of mind for many in the industry.
This move from niche to mainstream is expected to become even more prominent in the asset servicing industry over the next five years.
But while there has been much success in this area, industry participants will continue work to overcome the hurdles and work towards a standardised approach and tackle the issues surrounding ESG data.
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