ESG InvestingJun 16 2022

How are regulators ensuring ESG investing is considered?

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How are regulators ensuring ESG investing is considered?
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The UK government and others around the world have made strong environmental commitments at summits such as Cop26 in Glasgow. Those commitments drive government policy, which drives government legislation, which in turn drives regulation. 

So, there is a combination of global, EU and UK regulations and initiatives that are quickly changing the landscape in all sorts of areas, but in particular in financial services. 

The reason for this is that the financial sector has been recognised as having an especially strong influence in delivering global and domestic climate and environmental objectives. 

There are initiatives from the UN such as:

  • the UN principles for responsible investment (principles for incorporating ESG issues into investment practices);
  • the UN global compact (a principles-based approach to business practice aligned to human rights, labour, environmental and anti-corruption standards); and
  • the UN sustainable development goals (a framework of 17 sustainable development goals designed to balance outcomes of social, economic and environmental sustainability).

There are other global initiatives such as the taskforce for climate-related financial disclosures (TCFD), a global framework set out by the Financial Stability Board to develop consistent climate-related financial risk disclosures for use by companies, banks, and investors in providing information to stakeholders. 

As well as the net zero asset managers initiative, a global initiative with 236 signatories with $57.5tn (£47.6tn) in AUM, setting ambitious commitments to achieve net-zero emissions.

 

 

It’s pretty clear that regulators and policymakers are using ESG to re-inject a long-term focus back into investment activity.Ryan Medlock, Royal London

 

 

 

Last December the Financial Conduct Authority published its rules aimed at asset managers, life insurers and FCA-regulated pension providers to make climate-related disclosures consistent with the recommendations of the TCFD.

Additionally, the sustainable finance disclosure regulation, which was introduced by the European Commission in 2019 and came into effect in 2021, imposes mandatory ESG disclosure obligations for asset managers, requiring them to report on both the impact of sustainability risks on the investments, as well as the principal adverse impacts of their investments on sustainability factors.

Both the SFDR and TCFD require investment managers to make both entity-level and product-level disclosures. 

However, one of the key differences is that the SFDR is broader than the TCFD, given that it covers all ESG risks as opposed to just climate change. 

Ryan Medlock, senior investment development and technical manager at Royal London, says: “There has been an explosion in various ESG-related regulatory proposals over recent years and it’s pretty clear that regulators and policymakers are using ESG to re-inject a long-term focus back into investment activity. 

“This has predominantly been from an EU perspective with the EU sustainable finance action plan central to these aims. In the UK, we’ve been looking at these developments as a direction of travel that the UK is likely to adopt and that is starting to turn to fruition as clarity emerges.”

Terminologies

In the UK, one of the key concerns of the FCA is the huge collection of terminologies that relate to this area: ethical, socially responsible, impact investing, sustainable and so on. 

The challenge is not just the number of different terms, it is the lack of a commonly accepted framework for discussion – many of these terms overlap or are understood differently by different people. This creates a confusing market. 

To help with this, in November last year the FCA released a discussion paper on sustainability disclosure requirements and investment labels, to help create clarity in this area. 

The discussion paper is aimed initially at product manufacturers – that is, fund managers – as opposed to financial advisers, but the FCA does state: "This paper focuses on the elements of SDR relevant to firms involved in investment management and decision-making processes.

"However, we recognise the important role that financial advisers play in providing consumers with sufficient information to assess which products meet their needs.

"We are also exploring how to introduce rules for financial advisers, given the role they play in the investment chain. Building on existing rules, we consider it would be appropriate to confirm that advisers should consider sustainability matters in their investment advice and ensure their advice is suitable and reflects consumer sustainability-related needs and preferences."

The discussion paper will be followed up by a consultation paper, expected before the end of June.

The current thinking is to have three broad headings for all funds:

  • Not promoted as sustainable.
  • Responsible.
  • Sustainable.

It will be a while before these proposals come into force, but it does show the direction of travel. 

Not 'if', but 'how'

So, the question has gone beyond whether advisers should be discussing ESG matters, it is becoming just as important to focus on how they discuss the area with clients, and how they record that conversation. 

Medlock says: "A key aim for the regulator is to ensure that advisers take sustainability matters into account within their advice processes and understand investors’ preferences on sustainability to ensure their advice is suitable.

“This mirrors the EU’s approach in this area. It also intensifies the need for the advice community to start thinking about how sustainability considerations can be embedded within existing advice processes if they aren’t already, as well as formally asking and engaging with clients on sustainability themes and recording the responses within suitability reports.”

A survey in April conducted by NextWealth and sponsored by Parmenion found that 77 per cent of advisers thought that they were required to take into consideration client views on climate change, sustainability and ethical investments when making product recommendations.  

The bottom line is that it's becoming impossible to ignore the investor demand in the market.Alix Lebec, Lebec Consulting

When it comes to whether advisers should be taking a client’s sustainability preferences into account as part of their suitability requirements, this is something the FCA expects.

At an event back in January, FCA technical specialist of sustainable finance and stewardship, Mark Manning, said: “ESG is already in scope when advisers give investment advice. Under existing rules, firms have to act in a client’s best interest and collect all necessary information to understand the client’s investment objectives.

“In that context suitability, within our conduct of business rules, already requires the consideration of ESG preferences.”

The discussion paper builds on the TCFD recommendations and covers three different types of disclosure: corporate/asset manager, asset owner, and investment product disclosures. 

It also includes proposals for a much-needed labelling regime, which is an attempt to standardise the terminology used to label different responsible investment approaches.

Alix Lebec, founder and chief executive of Lebec Consulting, says: “The bottom line is that it's becoming impossible to ignore the investor demand in the market. 

“Regulators are taking actions to ensure that the investment industry has momentum in the direction of change. Essentially, asset managers make the choice of complying or becoming obsolete.”

Ima Jackson-Obot is deputy features editor at FTAdviser