Our FBC round table on 15 March 2023 focused on the role of the fund board in overseeing sustainable investment funds. The conversation started with FBC senior adviser Brandon Horwitz interviewing Clare Wood, a fund board director at First Sentier Investors (UK) Limited, about her experiences. The discussion swiftly opened up with candid views from the other fund board directors and senior fund governance professionals in attendance.
A clear message emerged that the FCA expects firms to have robust controls in place to address potential ESG (Environmental, Social and Governance) and sustainable fund issues, as highlighted in their July 2021 Dear Authorised Fund Manager (AFM) Chair letter. A number of firms have already been visited by the FCA as part of thematic work to follow up on the expectations set out in this letter.
Oversight of sustainable investments also featured in the FCA’s February 2023 portfolio letter to asset managers and discussion paper on finance for sustainable change covering governance, incentives and competence in regulated firms. It was also clear that the FCA expects firms to have taken action to meet existing fund rules, with more work required to comply with the upcoming Sustainability Disclosure Requirements (SDR) and investment labelling rules (which come into force in 2024).
The discussion highlighted that while the FCA’s 2021 letter clarified the UK regulatory expectations, many firms had already taken steps to enhance oversight of ESG elements of funds to meet the EU’s Sustainable Finance Disclosure Regulation (SFDR) requirements.
A number of the attendees had already been visited by the FCA as part of the thematic review of ESG and sustainable investment funds. A common experience was the FCA drilling into substantial detail on how ESG was practically incorporated into the investment process, including asking detailed questions about individual stock selection.
There was some debate about whether it was appropriate to expect an AFM and its board members in particular to be experts on the detail of why individual stocks were selected in a portfolio. The argument against this was that the AFM sets the mandate for funds and the investment manager was responsible for detailed investment decisions.
It was felt that the AFM should reasonably be held accountable for ensuring appropriate systems and controls are in place to oversee the investment manager’s activities (including compliance with a fund’s mandate). Attendees noted, however, that the FCA interviews typically covered both AFM and investment manager activity, so it was wise to have relevant fund managers in the room to answer any detailed stock specific questions.
Attendees also noted a major focus on stewardship and how relevant activities were measured including what sort of Management Information (MI) was used to oversee these activities. The notion of ‘causality’ also featured in discussions, with the FCA interested in if and how a fund manager’s engagement activities can be specifically linked to particular outcomes within an investee firm (and potential impact on the environment and/or society).
There was a robust discussion about how much expertise a fund board should have when it comes to sustainable investment, with acknowledgement that individual members could offer skills ranging from more general oversight and control expertise through to deep ESG expertise. The general conclusion was that the board should have an appropriate balance between these skills which could vary depending on the nature of the funds for which they are responsible.
From a Consumer Duty perspective, we discussed how the fund board should be satisfied with how a sustainable fund is described to retail customers. However, it was also acknowledged that the finer detail of scrutinising individual investments could be better suited to other forums. This could include a sustainability or investment oversight committee reviewing outliers which might be identified though assurance work undertaken by the second line of defence (e.g. investment risk teams). Any significant and persistent issues would then be escalated to the fund board.
The meeting concluded with a discussion of the complexities and nuances of sustainable investing, including the limitations of data availability to use traditional pre and post trade compliance systems for control purposes. These complexities and limitations highlight the importance of appropriate expertise both in the first and second line of investment management businesses and on the boards of AFMs to meet the challenges of effective oversight of sustainable investment funds.
FBC Corporate Members can view the full recording of the round-table discussion.
Brandon Horwitz closed the meeting and mentioned that FBC offers a sustainable investment fund oversight review service to help provide fund boards with assurance in this space. More details are available here.