A green future
03 Feb 2021
It is key for firms to consider ESG into their strategies, but problems around data and interpretation on different shades of green threaten to get in the way. With new developments and the upcoming SFDR, industry experts are optimistic about ESG for 2021 and beyond
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It is well known that environmental, social and governance (ESG) and socially responsible investing has become widely recognised in the financial services industry over the last few years. An asset servicing survey from Cooper Wood & Associates affirmed this recently as the figures revealed that 57 per cent of respondents named ESG and socially responsible investing as the sectors they think UK investors will most likely be focussing on in 2021.
ESG can be referred to as an umbrella term for investments that seek positive returns and long-term impact on society, environment and the performance of the business. Sustainable finance includes a strong green finance component that aims to support economic growth while reducing pressures on the environment, addressing greenhouse gas emissions, tackling pollution, minimising waste and improving efficiency in the use of natural resources.
Experts say ESG measurement and analysis has been embraced by public markets and listed businesses over the last few years, however, in 2020 their counterparts in the private markets have taken notice.
“Under growing pressure from institutional investors and regulators, and as evidence for the link between financial performance and ESG factors grows, ESG has become more than just a ‘box ticking’ exercise for private markets,” says Andy Pitts-Tucker, managing director Apex ESG Ratings & Advisory.
Participants can expect the developments in the ESG space to continue to grow in 2021 and beyond despite challenges along the way.
Increased demand?
Although it has been highlighted that there is not a notably increased demand for ESG fund services for the time being, the pandemic has not affected the appetite for ESG investing and ratings in a negative way. The pandemic has sharpened the focus on risks of all types.
At PwC, Olivier Carre, financial services leader, believes that demand for ESG fund services is materialising in somewhat of a cycle, in which it is currently too early for a notable increase in this demand to take place.
The cycle consists of three steps: risk, accounting, and annual reports.
At this stage, demand appears to be limited to data and risk management services relating to ESG related criteria and ESG related instrument criteria.
That being said, experts expect to see this demand for ESG-oriented fund services to extend to accounting and valuation in the future. Carre predicts this demand extending also to annual reports.
“Crucially, once we come out of the other side of the crisis, funds are in a unique position to act as change agents to build back stronger economies, and ESG considerations must play an integral part in this rebuilding,” adds Apex’s Pitts-Tucker.
In terms of the product offering, investors want their service providers to offer ESG analytical and portfolio reporting capabilities that sit alongside the other more traditional metrics that are part of the reporting.
A specific example of this is the European Union’s new Sustainable Finance Disclosure Regulation (SFDR), which comes into effect in March 2021. SFDR imposes new transparency obligations and periodic reporting requirements on investment management firms at both a product and manager level.
ESG developments and strategies
Despite there not being a spike in demand for ESG fund services, the demand for more sustainable products has increased across all industries. This means that firms are having to consider ESG in their strategies, moving it up towards the top of their agenda.
Investors, therefore, need to be aware of the trends, risks and opportunities in this space. For example, assets will reprice and capital will be deployed recognising embedded ESG risks and using the lens of stakeholder returns, not just shareholder returns.
Experts stress that it is imperative that firms consider ESG in their strategies.
Carre explains that ESG represents the opportunity of the century for these firms to make a positive contribution to the society in which they operate, all while aligning with the needs and wants of the investment ecosystem.
Pitts-Tucker adds: “The dominant trend driving this appetite for ESG transparency from funds is that their stakeholders are demanding greater non-financial disclosure and ESG reporting, ‘pushing’ investors towards ESG. Investors such as pension funds are now considering the ESG policies of the funds they invest in, as part of their fiduciary responsibilities to their underlying investors.”
He continues: “We anticipate that soon private equity firms will be required to pass an ESG screening as part of their vetting process as their investors demand more transparency into the funds’ ESG policies, procedures as well as the non-financial performance of the underlying portfolio assets.”
In terms of developments bubbling in this area, 2021 has the potential to be a pivotal year for ESG in its growth trajectory therefore ESG has become a key agenda item as firms consider their ESG strategies.
At Citi, Elree Winnett-Seelig, global head of ESG for markets and securities service, observes a proliferation and evolution of ESG products in the market, beyond simple exclusionary screens in equities.
According to Winnett-Seelig, ESG is reflected in all of the asset classes and the services asset managers and owners want, which is natural given the increased ESG sophistication of clients, as well as the level of ESG integration in their platforms and businesses.
In terms of products, Citi has also identified a dramatic uptick in interest in thematic funds and fixed income strategies from its institutional clients.
“Many of our clients are also starting to look at ‘dual-return’ strategies where they seek not just financial return, but also ESG outcomes,” says Winnett-Seelig.
Aligning ESG requirements with investment goals
Amid increased interest and growth around ESG, there are also notable challenges that UK and European investors face when it comes to sustainability and aligning ESG requirements with their investment goals.
Different shades of green; the varied definitions and objectives of ESG, have caused a lack of harmonisation of ESG policy and regulation. However, this is where SFDR will prove to be advantageous.
One significant issue, as Winnett-Seelig points out, is the UK’s possible divergence from the EU ESG taxonomy/disclosure rules which will add complexity to comparing products and performance.
“That being said, the UK’s new pension rules are supportive of ESG and climate change because they require that trustees outline their approach to engagement with and voting of their shares in investee companies, and how they take account of financial material factors, including ESG and climate change considerations, in investment decision making,” says Winnett-Seelig.
In addition, there are data quality issues, problems with resourcing and scaling ESG integration across the business plus the rapid evolution of ESG in the market, and product availability challenges too.
Discussing data issues, Carre explains: “Investors are having to synthesise and interpret a growing range of disjointed information: such as various national requirements, private sector initiatives and voluntary ESG principles. For many investors, this lack of ESG comparability represents a significant barrier to entry.”
A recent PwC survey found that 89 per cent of the institutional investors want more regulatory reporting for their ESG investments from the asset managers with which they invest.
Data inconsistencies and shortcomings represent a similar challenge within the retail segment, limiting the uptake of ESG investment.
In the survey of over 800 retail investors, over one third of those who do not consider ESG factors in their investments cited ambiguities surrounding the objective evaluation of the ESG impact on investments as their reason for not doing so.
Growth in 2021 and beyond
Despite the challenges, industry participants are optimistic this space will continue to expand in 2021 and over the next few years, with ESG becoming the new business-as-usual.
Experts predict supranational bodies and economic unions are introducing new regulation which will define the space in the years to come.
“Notably, we are now less than four months from the introduction of the EU SFDR in March 2021. This legislation introduces the regulatory imperative for funds to better understand the ESG status of their portfolio investments and will require fund managers to report on the sustainability characteristics of their investments,” says Apex’s Pitts-Tucker.
He adds: “From what we have seen, there are some businesses which are well set up and focused on this regulation, however, the bulk are nowhere near ready, both in terms of really understanding what it means and being able to comply with the reporting demands.”
In line with SFDR, ESG Disclosure is set to improve, alongside more sophisticated artificial intelligence, which will enhance data quality on which industry participants make decisions, including time series linked to sustainability outcomes.
“With experience and better data, products and strategies will become more sophisticated, moving from applying exclusionary screens to or reweighting existing indices to bottom-up portfolio construction to achieve an outcome,” says Winnett-Seelig.
Carre concludes: “We [PwC] believe that ESG will represent the fastest growing area within the Asset and Wealth Management industry this decade and stands to redefine the entire European fund landscape. The implementation of the EU Action Plan and SFDR will see a significant impact not only on products, but also financial agents and fiduciary investors.”
ESG can be referred to as an umbrella term for investments that seek positive returns and long-term impact on society, environment and the performance of the business. Sustainable finance includes a strong green finance component that aims to support economic growth while reducing pressures on the environment, addressing greenhouse gas emissions, tackling pollution, minimising waste and improving efficiency in the use of natural resources.
Experts say ESG measurement and analysis has been embraced by public markets and listed businesses over the last few years, however, in 2020 their counterparts in the private markets have taken notice.
“Under growing pressure from institutional investors and regulators, and as evidence for the link between financial performance and ESG factors grows, ESG has become more than just a ‘box ticking’ exercise for private markets,” says Andy Pitts-Tucker, managing director Apex ESG Ratings & Advisory.
Participants can expect the developments in the ESG space to continue to grow in 2021 and beyond despite challenges along the way.
Increased demand?
Although it has been highlighted that there is not a notably increased demand for ESG fund services for the time being, the pandemic has not affected the appetite for ESG investing and ratings in a negative way. The pandemic has sharpened the focus on risks of all types.
At PwC, Olivier Carre, financial services leader, believes that demand for ESG fund services is materialising in somewhat of a cycle, in which it is currently too early for a notable increase in this demand to take place.
The cycle consists of three steps: risk, accounting, and annual reports.
At this stage, demand appears to be limited to data and risk management services relating to ESG related criteria and ESG related instrument criteria.
That being said, experts expect to see this demand for ESG-oriented fund services to extend to accounting and valuation in the future. Carre predicts this demand extending also to annual reports.
“Crucially, once we come out of the other side of the crisis, funds are in a unique position to act as change agents to build back stronger economies, and ESG considerations must play an integral part in this rebuilding,” adds Apex’s Pitts-Tucker.
In terms of the product offering, investors want their service providers to offer ESG analytical and portfolio reporting capabilities that sit alongside the other more traditional metrics that are part of the reporting.
A specific example of this is the European Union’s new Sustainable Finance Disclosure Regulation (SFDR), which comes into effect in March 2021. SFDR imposes new transparency obligations and periodic reporting requirements on investment management firms at both a product and manager level.
ESG developments and strategies
Despite there not being a spike in demand for ESG fund services, the demand for more sustainable products has increased across all industries. This means that firms are having to consider ESG in their strategies, moving it up towards the top of their agenda.
Investors, therefore, need to be aware of the trends, risks and opportunities in this space. For example, assets will reprice and capital will be deployed recognising embedded ESG risks and using the lens of stakeholder returns, not just shareholder returns.
Experts stress that it is imperative that firms consider ESG in their strategies.
Carre explains that ESG represents the opportunity of the century for these firms to make a positive contribution to the society in which they operate, all while aligning with the needs and wants of the investment ecosystem.
Pitts-Tucker adds: “The dominant trend driving this appetite for ESG transparency from funds is that their stakeholders are demanding greater non-financial disclosure and ESG reporting, ‘pushing’ investors towards ESG. Investors such as pension funds are now considering the ESG policies of the funds they invest in, as part of their fiduciary responsibilities to their underlying investors.”
He continues: “We anticipate that soon private equity firms will be required to pass an ESG screening as part of their vetting process as their investors demand more transparency into the funds’ ESG policies, procedures as well as the non-financial performance of the underlying portfolio assets.”
In terms of developments bubbling in this area, 2021 has the potential to be a pivotal year for ESG in its growth trajectory therefore ESG has become a key agenda item as firms consider their ESG strategies.
At Citi, Elree Winnett-Seelig, global head of ESG for markets and securities service, observes a proliferation and evolution of ESG products in the market, beyond simple exclusionary screens in equities.
According to Winnett-Seelig, ESG is reflected in all of the asset classes and the services asset managers and owners want, which is natural given the increased ESG sophistication of clients, as well as the level of ESG integration in their platforms and businesses.
In terms of products, Citi has also identified a dramatic uptick in interest in thematic funds and fixed income strategies from its institutional clients.
“Many of our clients are also starting to look at ‘dual-return’ strategies where they seek not just financial return, but also ESG outcomes,” says Winnett-Seelig.
Aligning ESG requirements with investment goals
Amid increased interest and growth around ESG, there are also notable challenges that UK and European investors face when it comes to sustainability and aligning ESG requirements with their investment goals.
Different shades of green; the varied definitions and objectives of ESG, have caused a lack of harmonisation of ESG policy and regulation. However, this is where SFDR will prove to be advantageous.
One significant issue, as Winnett-Seelig points out, is the UK’s possible divergence from the EU ESG taxonomy/disclosure rules which will add complexity to comparing products and performance.
“That being said, the UK’s new pension rules are supportive of ESG and climate change because they require that trustees outline their approach to engagement with and voting of their shares in investee companies, and how they take account of financial material factors, including ESG and climate change considerations, in investment decision making,” says Winnett-Seelig.
In addition, there are data quality issues, problems with resourcing and scaling ESG integration across the business plus the rapid evolution of ESG in the market, and product availability challenges too.
Discussing data issues, Carre explains: “Investors are having to synthesise and interpret a growing range of disjointed information: such as various national requirements, private sector initiatives and voluntary ESG principles. For many investors, this lack of ESG comparability represents a significant barrier to entry.”
A recent PwC survey found that 89 per cent of the institutional investors want more regulatory reporting for their ESG investments from the asset managers with which they invest.
Data inconsistencies and shortcomings represent a similar challenge within the retail segment, limiting the uptake of ESG investment.
In the survey of over 800 retail investors, over one third of those who do not consider ESG factors in their investments cited ambiguities surrounding the objective evaluation of the ESG impact on investments as their reason for not doing so.
Growth in 2021 and beyond
Despite the challenges, industry participants are optimistic this space will continue to expand in 2021 and over the next few years, with ESG becoming the new business-as-usual.
Experts predict supranational bodies and economic unions are introducing new regulation which will define the space in the years to come.
“Notably, we are now less than four months from the introduction of the EU SFDR in March 2021. This legislation introduces the regulatory imperative for funds to better understand the ESG status of their portfolio investments and will require fund managers to report on the sustainability characteristics of their investments,” says Apex’s Pitts-Tucker.
He adds: “From what we have seen, there are some businesses which are well set up and focused on this regulation, however, the bulk are nowhere near ready, both in terms of really understanding what it means and being able to comply with the reporting demands.”
In line with SFDR, ESG Disclosure is set to improve, alongside more sophisticated artificial intelligence, which will enhance data quality on which industry participants make decisions, including time series linked to sustainability outcomes.
“With experience and better data, products and strategies will become more sophisticated, moving from applying exclusionary screens to or reweighting existing indices to bottom-up portfolio construction to achieve an outcome,” says Winnett-Seelig.
Carre concludes: “We [PwC] believe that ESG will represent the fastest growing area within the Asset and Wealth Management industry this decade and stands to redefine the entire European fund landscape. The implementation of the EU Action Plan and SFDR will see a significant impact not only on products, but also financial agents and fiduciary investors.”
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