The temperature continues to rise on Environmental, Social and Governance (ESG) funds, with chilling examples of greenwashing enforcement in the USA (involving BNY Mellon) and Germany (involving DWS). Fund boards play an essential role in overseeing how ESG is implemented in funds, so what should they be doing to help keep their funds on the right flightpath?
FBC have been researching this question in recent months, speaking with dozens of fund board directors and other professionals around the world to understand how they oversee ESG funds. We have also researched what regulators currently expect of firms, as well as the emerging direction of travel.
Where we are headed
We think that the destination is fairly clear today and that we need to get to a place where:
- Fund labels, objectives, literature and marketing are all clear and not misleading about the nature of the ESG features which they offer
- ESG policies and processes are clearly articulated by the funds’ investment managers and well understood by the fund board
- Strong systems and controls are in place to oversee ESG funds (and funds which integrate ESG) to ensure they are being managed consistently with how they are described
Are we there yet?
Our research suggest that a small number of fund boards are in the air en route to this place, starting to ask the right questions and incorporating the answers into their oversight work. However, the vast majority are in the departure lounge on the way to their gate to embark … and a good few are at home, still hunting around for their passports!
Even more concerning than those who haven’t left yet, are the fund boards which don’t think they need to go on a journey at all. For example, some directors told us that it wasn’t the fund board’s job to oversee the minutiae of how individual funds invest as that was the executive’s responsibility.
We also had some directors disagreeing with the notion of fund boards engaging in discussing and understanding ESG investing policy. They felt that this level of detail was more appropriate for the executive teams, but they did pause when we highlighted that the fund board will be held accountable if that policy is found wanting.
While we agreed that detailed execution of ESG policy is an executive responsibility, we identified that few fund board directors felt comfortable explaining something as simple as whether a fossil fuel energy company would be considered ‘green’ or ‘brown’ by their investment managers. The answer depends on whether the investment manager’s ESG categorisation model is more focused on greenhouse gas emissions today or gives credit for a company’s investment and plans to align with a climate transition path.
This simple example matters because it goes to the heart of ESG oversight and the practical question of whether the investments in ESG funds can genuinely be defended as being ‘green’ – admittedly for a given definition of green!
How do we get there?
We think that fund board directors need to swiftly earn their wings when it comes to all things ESG, and some of the key things they can do include:
- Ask questions about ESG policy and processes – find out what your investment manager does, why this is the case and how they execute it (including what controls are in place from a first line business perspective)
- Scrutinise the Management Information (MI) the board receives – look at the MI which you receive about ESG and consider if it gives you confidence that the policies and processes are being implemented as you would expect (and if you don’t receive MI on ESG matters, ask why not!?)
- Use your three lines of defence – the fund board can’t oversee every detail of how ESG is implemented by itself, familiarise yourselves with the systems and controls in place to implement ESG in the first line by the business and consider when to get assurance on the effectiveness of these controls from your second line (compliance monitoring, risk review) and third line (internal audit) teams.
- Know what you don’t know – be honest with yourselves as a fund board and acknowledge if you have gaps in your ESG knowledge and experience, and take action to close these gaps (with training, in-depth sessions with investment managers etc)
Need some help?
Do get in touch if you would like to explore how FBC could help your fund board get up to speed on overseeing ESG investments.
Where to next?
Just when you started feeling comfortable in your seat cruising towards better ESG fund oversight, the captain announces that you need to complete your landing form disclosing how your corporate entity is addressing climate change matters! The heading on form is something called Task Force on Climate-Related Financial Disclosures (TCFD) … Watch this space for future articles on this theme!
