ESG – A regulatory imperative
Expert: Tom Tayler, Senior Manager, Aviva Investors Sustainable Finance Centre for Excellence
Facilitator: Dave Edwards, Esperto Business Solutions
Session summary:
European regulatory initiatives on ESG are progressing at full speed, with a focus on governance/stewardship, appropriate risk management and controls, the classification of sustainable activities, ESG disclosures at a firm and product level and the integration of ESG considerations into regulation e.g., MiFID II, UCITS V, AIFMD, Solvency II and the IDD.
In the UK, the PRA and the FCA are continuing to focus on ESG issues, including managing and disclosing the financial risks from climate change, and the UK government will be determining the approach to new ESG measures from 2021 and beyond.
Wealth Managers and Financial Advisers need to understand the developing, and increasing, regulatory expectations to ensure that, amongst other things, clients are treated fairly, stewardship responsibilities are appropriately discharged for asset owners and to help the industry manage any potential risks associated with ESG-misselling (sometimes known as ‘green-washing’).
This session will provide an opportunity for you to hear, share opinions with your peers and ask questions on the evolving ESG regulatory landscape.
How do you feel it will impact your business – not just the advice process
- Is it an opportunity or risk?
- Virtuous circle
- What questions to ask - CIP vs bespoke.
- Know your customers build long terms relationship
- What additional guidance is coming down the line?
- Democratisation of investment ‘Feedback.
Session Findings
There is an abundance of regulatory changes surrounding ESG and sustainable finance on the horizon for 2021.
These changes will provide a huge commercial opportunity for Advisory Businesses.
These regulatory changes along with changes in social behaviour are allowing clients to align more closely their savings and investment strategy with their personal values.
EU and UK regulators are using ‘sustainable finance’ to re-write the rule book and the volume and impacts of these changes should not be underestimated.
Despite Brexit we are still being led by EU rules and they will provide the best guide that the FCA will likely follow suit. This package of reforms will have a direct relevance to the UK retail market.
Recent feedback from advisers highlighted that 92% of advisers believe ESG strategies will form a larger proportion of their business.
The growing ESG market is not just driven by changes to regulation but equally driven by adviser and client demand.
Where clients are offered two products or investment solutions, one consisting of mainstream investment and an alternative with economic and sustainability factors, over 80% of clients will go with ESG!
Not only will the push and pull factors of regulation and clients shape the market, but the whole of the investment chain is also affected and playing a role.
Advisers, fund managers and potential investment targets will all be captured through regulation. The regulators across the market will be writing new rules on disclosure, taxonomy, categorization and process.
The SFDR disclosure requirements affect the EU from March 2021 and the FCA have indicated the same direction of travel and date for implementation.
Their ‘comply or explain’ approach will apply to all products, meaning that all elements of the advice chain will need to explain why ESG considerations are included and excluded. Product providers, pension fund managers, asset managers and advisers will be impacted.
The up-and-coming changes to regulation will also provide a base line for disclosure and highlight the need to reference risks associated with ESG to be part of any advice process.
Prospectuses and other disclosure documents like KIDD’s will be updated to show advisers and clients what ESG considerations have been undertaken or recorded as part of their due diligence process. There are likely to be two ratings – company level and fund level.
The move to having ESG as a key indicator will put pressure on pension funds to more disclosure. The likes of consumer group Make my Money Matter are also proving that putting pressure on pension funds is more impactful than clients changing spending behaviours.
There will be increased use of the 32 mandatory ESG indicators used to by businesses and fund managers to evidence sustainability, responsibility, and governance. The sector is hoping that this will develop into a balanced scorecard, although this has yet to be agreed due to the lack of data and too onerous processes to collate.
One thing is for sure that there will be increased reporting and metrics introduced to evidence a true ESG philosophy.
There is a view that the underlying philosophy of the regulator regarding ESG, is that of changing behaviour through disclosure.
In addition, suitability and consistency of client outcome remains a key focus for the FCA. Robust implementation of MifiD II will help to ensure that recommendations match clients risk appetite including sustainability appetite.
Discussing a client’s risk appetite and preference around ESG will be a mandatory part of the advice process. Fund rating agencies and technology suppliers are starting to build ESG into new and existing tools such as risk profiling, although there seems to be a lack of innovation or desire to pioneer at this early stage.
Changes to the way advisers engage with clients and document meetings via a fact find will be ways in which the firms can evidence assessing clients’ ESG preferences. This again will raise the bar for giving advice and drive clients to become more engaged as part of the process.
Importantly, sustainability should not be a trade-off for performance. There is evidence that investing to make a difference can deliver positive returns.
The different approach between active managers sees it as a point of potential differentiation and maintenance of margin against low-cost passive providers for whom it is quite difficult to provide clearly this level of due diligence.
Historically, there were exclusion-based funds or indices but going forward it is likely that ESG will be present in different shades across whole market.
Climate change is a universal risk and not a fund class or an investment style that clients, fund managers and asset managers can opt out of.
Summary
There is no doubt that the scope of regulatory change will deliver growth opportunities.
The challenge of matching up client preferences with solutions will be the main struggle of advisory businesses.
Investment research departments will need to develop methodology around scoring all the portfolios that they run on the ESG perspective.
Product and fund categorization will only help to bridge this gap.
However, advisers will need to spend more time x-raying existing holdings to identify and agree a client’s ‘red lines’ and exclusions.
Many clients are unaware of where pension funds are invested. Education of adviser and clients and their appetite to be more involved in the process will also derive speed of change.
This may result in a period of ‘Learning by doing’ to identify what good looks like.
We will also see a period of NGA’s like the Share Action – holding companies to account to challenge the market.
There will be pioneers on process and technology, and early adopter advisers and clients but one thing is for sure: ESG is here to stay and will become the ‘new normal’ going into 2021.
