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Leading the global investment management discussion

Asset managers to be judged on commitment to ESG principles

Mark Carney recently told banks and investment managers that they cannot ignore the effects of climate change. Are these major risks being addressed through current ESG discussions? This report from FundForum International 2019 in Copenhagen takes a look.

Climate change, and the potential systemic risks that it can create are something that institutional investors and market regulators are taking exceptionally seriously. Historically, the successful asset managers have been the ones who have generated alpha and beaten market benchmarks. Looking ahead, success at asset managers will be judged not just on returns but on their commitment to ESG (environment, social, governance) principles.

The systematic approach towards ESG

Speaking at Fund Forum International in Copenhagen, the Reverend Kirsten Spalding, senior department director, investor network at CERES, said that investors needed to take a systematic, market-wide approach towards ESG, as opposed to dealing with one company or asset class at a time. Spalding said it was a strategy that was employed well in areas such as human rights, for instance. But why is there now such an emphasis on ESG in funds?

There are several reasons explaining the sudden rise of ESG. Firstly, ESG assets are widely believed to perform better than standard securities. At a time when returns have been quite fickle, this can be a useful advantage for fund managers to have. In addition, investors are asking for ESG-linked returns, as operations teams increasingly recognise the long-term investment risks of having exposures to non-ESG assets.

"...Institutional investors are becoming increasingly proactive, and are clamping down hard on companies which have poor ESG practices."

For example, an institutional investor who owns shares in a company whose revenues are dependent on carbon emitting fuels or unsustainable business practices could potentially face huge losses if regulators or governments change the law and impose severe restrictions on fossil fuel consumption.

Is regulation pushing ESG into the spotlight?

Regulators themselves are driving ESG adoption too. In the EU, the Action Plan on Sustainable Finance will introduce new rules for institutions when investing in ESG assets, not least around disclosure amid rising alarm at the growth of greenwashing.

Elsewhere, the European Commission is in the process of drafting a comprehensive taxonomy or set of standards to help investors benchmark the sustainability of their asset managers. This is just one in a series of initiatives aimed at codifying best practices on ESG. Another panel session acknowledged the Financial Stability Board’s (FSB) Task Force on Climate Related Financial Disclosures (TCFD) had been particularly impactful on market-wide transparency on ESG.

Nonetheless, creating standards on ESG is not for the faint-hearted, not least because there are so many opinions on it. Speaking on the fringes, some asset managers and service providers warned that there were too many different ESG standardisation initiatives being rolled out, which was having a dilution effect and creating widespread confusion across retail and institutional investors. However, institutional investors are becoming increasingly proactive, and are clamping down hard on companies which have poor ESG practices.

 A more positive (and green) future?

Stephen Barrie, deputy director, ethics and engagement, acting secretary, Ethical Investment Advisory Group at the Church of England, said he was reviewing companies in carbon emitting sectors, adding that some firms are making a positive transition, although a number of them – principally those involved in the oil and gas industries – are reluctant to disclose much information. Despite this, he added Royal Dutch Shell had issued an encouraging statement outlining that it would tie executive remuneration packages to meeting emissions targets.

"In the EU, the Action Plan on Sustainable Finance will introduce new rules for institutions when investing in ESG assets, not least around disclosure amid rising alarm at the growth of greenwashing."

Other investors are pushing heavily on societal issues. Allan Polack, group CEO at PFA Pension, said that it was unsustainable for companies not to pay tax. He acknowledged a number of companies exploit arbitrages to lower their tax bills.

Such practices are fast becoming unpopular and it is likely socially conscious investors will begin to take a firmer line on such activities. Reverend Spalding highlighted that if money is moved in the right direction, then businesses will transform accordingly. Barrie added that effective lobbying through trade associations was essential if companies are to transition towards sustainability and meet their obligations laid out under Paris COP 21 and the UN SDGs.

Check back soon for more reports on conference sessions at FundForum International 2019.