The focus on ESG has grown apace, driven by increased social conscience and a collective move towards more sustainable options.
This has resulted in an explosion in ESG data and a demand for ESG ratings for board, investor, lender, consumer and other stakeholder decision making. The development and implementation of robust regulatory frameworks are following close behind.
Therefore, as part of its action plan on ESG, the EU published draft delegated acts on suitability assessments that would amend existing Level 2 measures under MiFID2.
The Commission's proposals reflect the recommendation set out in the Final Report of the High Level Expert Group that investment advisers should ask about, and then respond to, investors’ preferences regarding the sustainable impact of their investments, as a routine component of financial advice. This would involve clarifying an investor’s ESG preferences by means of a questionnaire.
The proposals also take into account ESMA’s Final Report on integrating sustainability risks and factors in MiFID2 (April 2019).
Investment advisers who thus far have resisted ESG investing will now have to start taking it into consideration, and if, post-Brexit, the UK’s financial regulation remains aligned with EU regulations, then the impact of the new regulations will also apply to UK advisers.
Additionally, transparency clauses will mean that advisers will need to include the extent to which sustainability risks are integrated into investment decisions and an assessment of the likely impacts of sustainability risk on client returns. So, even if none of their clients are interested in ESG, advisers will still need to demonstrate knowledge of ESG and a process that shows how ESG funds are identified, evaluated, selected and compared.
Research from Square Mile Investment Consulting and Research indicates that advisers feel that asset managers could do more to support their understanding of ESG by improving clarity of their materials and processes.
However, in our experience, whilst ESG has afforded the opportunity for asset managers to reach new investors, to develop new revenue streams, to bid for institutional pools of money from charities and public sector pension funds and to connect with millennial investors it has brought a set of unique challenges.
ESG ratings and benchmarks have experienced a rapid expansion, and with this an extraordinary degree of fragmentation. The World Business Council for Sustainable Development (WBCSD) reports that there are over 2,000 individual ESG reporting indicators requested by the approximately 600 ratings and benchmarks.
On top of the fragmentation issue there is the question of definition. Without a consistent definition of what ESG ratings are supposed to measure or even a consistent view of what constitutes a relevant ESG issue, it is difficult to gauge their effectiveness.
Asset managers may find themselves; managing the demands of investors for more frequent and granular ESG data; sifting through the overwhelming volume of ESG market data, metrics and risk profiles; and supporting (prospective) portfolio companies who often lack the resources and know-how to develop their ESG risk profiles.