How will regulatory changes impact ESG?

Regulatory changes are being introduced around the role of the adviser, with a requirement that clients must, during the suitability questionnaire, have ESG exposure mentioned to them. 

John David, head of Rathbone Greenbank investments, says the changes to the suitability rules are likely to lead to “significant” inflows into the ESG sector in the years ahead.  

That rule around suitability is being introduced at the EU level and may change as a result of the current negotiations between the EU and the UK over their long-term trading relationship.

Cathrine de Coninck-Lopez, global head of ESG at Invesco, says that if clients have to be asked if they want an ESG product then “more will say yes” and this will help demand for portfolios.  

A standard law of markets is that if an asset class becomes deeply fashionable then the increased volume of cash chasing the same assets means the price of those assets will rise, and so become less attractive as investments in the future.  

Mona Shah, ESG investor at Stonehage Fleming, says her focus is on finding “the good companies of tomorrow, many of which are not the good companies of today. Today they are averagely priced”.

Energy entropy 

Patrick Thomas, who heads up the ESG service at Canaccord Genuity Wealth Management, says: “There tends to be an element, more in the passive ESG area, of mission creep, where for example, the Social Responsible Index has oil companies in it. Generally I don’t see the best performing active ESG funds stretching the limits of what ESG is. 

"Thematic funds are a good way to keep a manager honest, and it is governments who are driving the policy right now, and the funds follow that.” 

He doesn’t believe there is generally a bubble in ESG assets, though, he is wary that some of the renewable energy assets are moving towards valuations that may look like a bubble. 

David Czupryna, head of ESG at Candriam, argues there is no sign of a bubble “unless you only use the narrow definition of ESG as environmental and climate change assets”. 

Some fund managers are hopeful that regulation which clarifies the terminology will be introduced.

Greg Mullins, head of sales at Rathbones Unit Trust Management, says ESG is an area which is growing rapidly, with changing investor sentiment and appetite being met with almost weekly launches of ESG investment products and solutions.

Thematic funds are a good way to keep a manager honest.--Patrick Thomas

"On top of this we have ongoing regulatory change which will ensure this becomes critical in the advice process, with all clients having their personal values and preferences explored, discussed and catered for," adds Mr Mullins. 

"As with any new or rapidly growing area there will be confusion as investment groups rush to be involved regardless of their strengths, trying to appeal to the widest possible audience. This will fuel confusion and make research, recommendations and genuine like-for-like comparisons extremely difficult.

"My hope is that the regulator will bring in universal definitions across the industry, thus forcing fund groups to make choices. It is also critical that fund houses are absolutely clear about what their offerings are and just as importantly, are not, and who their intended audience is.”

Being informed

Better education can also help individuals to have a better understanding of the terminology.

Benjamin Matthews, investment manager at Heartwood, says: “When it comes to definitions in the field of sustainable, responsible, ESG investing, clear regulation would of course improve the situation. However, broader education is also important.

"For example, asset managers and advisers could consider taking on the CFA ESG certificate – a fantastic tool for learning about different definitions and approaches. This course covers the spectrum of these types of investments, and discusses the varied investment profiles offered by the subtly different categorisations.”

Nicolo Bragazza, investment analyst, portfolio management at Morningstar Investment Management says a challenge with the definitions of ESG out there is that many funds and companies tend only to focus on the environment, or green, part of ESG and neglect the rest.    

My hope is that the regulator will bring in universal definitions across the industry, thus forcing fund groups to make choices.--Greg Mullins

He adds: “Recently a lot of attention has been devoted to environmental issues meaning many funds are applying environmental based screenings and exclusions. This is not a high enough threshold for proper ESG integration as it misses the “S” and “G” which are just as important as the “E”.

Frederic Samama, chief responsible investment officer at CPR Asset Management, highlights two examples he believes show how uncontrolled the present use of the term ESG is.

He says: “As an example, some mining companies have a very good ESG rating although generating some massive externalities. And Tesla that is helping shift the entire autocar manufacturing industry therefore has a massive impact on society sometimes has a very bad ESG rating.”

Sara Razmpa, head of responsible investing at Unigestion, says regulation will help the industry, as it would create more transparency about what everyone is doing.

Term limits 

Malcolm McPartlin, portfolio manager on the sustainability team at Aegon Asset Management says: “The traditional definition of impact investing is being stretched and in some instances misused.  Bold marketing claims can often lead investors to believe there is a 'magic green button'.

"However, ESG investing is rarely black and white, and time must be taken to understand and debate the nuances.”