12th May 2021
Exploring the developing themes of environmental, social, and governance investing with the aid of Helena Coles, independent investment adviser and iNED.
Understanding a director’s and a board’s responsibilities in relation to ESG is a complex task.
The investor demand for ESG-themed strategies is clear: more than $152bn (£110bn) flowed into such products in the fourth quarter of 2020, according to Morningstar – a record amount. By the end of last year there was estimated to be $1.7trn invested in ESG funds.
The performance case is getting stronger, particularly over recent years, resulting in a reassessment of the previously held belief that investing responsibly meant giving up returns. Regulation is catching up, too. The European Union has begun implementing its Sustainable Finance Disclosure Regulation (SFDR), which sets stringent classification criteria for funds marketing themselves as ‘green’ or ‘ESG friendly’.
In the UK, while the SFDR does not apply, the government has set out an ambitious “road map” for green finance, seeking to align the corporate and financial worlds with the recommendations of the international Task Force for Climate-related Financial Disclosures (TCFD) as part of a wider effort to cut carbon emissions by 78% by 2035. Rules for asset managers are expected to be implemented over the next two years, while rules for major investors such as pension funds are already being rolled out.
What does all this mean for fund boards? How can iNEDs help their boards avoid the pitfalls of changing and evolving regulations and standards? And how can asset managers avoid ‘greenwashing’?
Helena Coles, an iNED and independent investment adviser, speaks to FBC’s Brandon Horwitz on this subject at the 2021 iNED Bootcamp. She says asset managers do not have a choice on whether to incorporate ESG criteria – their clients and regulators demand it.
Recent co-ordinated actions from investors show the direction of travel. The Institutional Investors Group on Climate Change, for example, brought together major asset owners to put pressure on banks to reduce the amount they lend to companies with high carbon emissions.
“I think that ESG is now so clearly such an important issue that it is a regulatory and reputational risk if you’re not seen to be getting on with it and doing the right thing,” she explains. “It is reputational risk over regulatory risk, I would say, because I think increasingly what you do and how you do it is becoming a part of your brand and your social licence to operate.”
While it helps reputationally, firms are also taking the initiative on ESG matters in part because of the lack of consistency of data, reporting, and regulatory frameworks. Voluntary initiatives such as the TCFD and Net Zero Asset Managers have gained significant traction in a relatively short space of time as providers have sought to demonstrate their genuine commitment to ESG goals.
Transparency of methodologies and processes is key to avoiding accusations of ‘greenwashing’ – i.e., funds that appear more ESG-friendly than they are. With the wide range of strategies available, it is crucial to ensure investors and other stakeholders understand exactly what each product is trying to achieve.
As Coles says: “Unfortunately, it’s all too easy to greenwash at the moment. There are so many different definitions of what is green and what is sustainable, and it’s almost impossible for an investor… to pick through what is actually inside the box.”
Asset managers will need to remain flexible as regulations develop, in particular regarding disclosure requirements. SFDR is in its early stages, and managers and analysts alike are preparing for the next phases of implementation, as well as other new rules and regulations expected to hit the financial services sector over the next few years. In the US, the new administration has refocused regulators on ESG issues, and in particular climate change, but these organisations are still working out the best way to proceed.
In the UK, the FCA is expected to consult on new rules for the investment industry to be rolled out over the next couple of years. These are expected to include requirements to disclose ESG strategies, policies and processes at a firm level, “complemented by more targeted disclosures at the fund or portfolio level”. The scope of the proposed rules is yet to be determined, but the regulator has been instructed to “set a scope that prioritised the information needs of UK clients and end-investors”.
For asset managers and fund boards, the key to staying ahead of these changing regulations is asking the right questions, Coles says. Finding that killer question to put to the fund manager can be very simple.
“It starts really from ‘How do you invest?’,” she explains. “Talk me through your investment process, your philosophy. Walk me through an example of a stock you ended up buying; walk me through the journey of a stock you did not end up buying.
“Everybody is claiming that they integrate ESG, but I think it is very evident when somebody starts to walk you through a stock idea. Where the ESG factors mesh in around the financial factors is critical.”
This would allow for further discussion and debate about engagements with portfolio companies that have and have not worked. In addition, fund boards can assess whether the investment case for a particular asset was genuinely influenced by proper consideration of ESG factors, or whether these have been applied in hindsight.
Ultimately, for Coles, it is a question of the collective responsibility of asset managers to act on ESG issues.
She says: “The asset management industry has an enormous role to play, and an enormous responsibility as stewards of capital to deploy it in a way that can influence better behaviours and better outcomes. In that context, the more weight you have, and the more voice you have, the better the potential outcomes, and collaboration can play an important part in that ability to influence.”
FBC members can access Helena Coles’ conversation with Brandon Horwitz on demand as part of the 2021 iNED Bootcamp through the Member Portal.
 Source: Reuters, ‘Sustainable fund assets hit record $1.7 trln in 2020: Morningstar’, 28 January 2021. https://www.reuters.com/article/us-global-funds-sustainable-idUSKBN29X2NM
 Source: Financial Times, ‘Coalition of big investors pushes banks to defund carbon emitters’, 18 April 2021. https://www.ft.com/content/cad45ac2-3778-4db6-a43c-96b83b195516
 Source: HM Treasury, ‘Interim Report of the UK’s Joint Government-Regulator TCFD Taskforce’, November 2020. https://www.gov.uk/government/publications/uk-joint-regulator-and-government-tcfd-taskforce-interim-report-and-roadmap