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29 May 2019

When No One-Size-Fits-All: Examining ESG integration

Regulatory momentum around environmental, social and governance (ESG) factors has been increasing at a rapid pace over recent years. In May 2018, the Commission adopted a package of measures implementing several key actions announced in its ground-breaking Action Plan for Financing Sustainable Growth that outlines an ambitious agenda to “re-engineer financial markets”, overhaul existing regulation, and create new tools to mainstream ESG.  

In addition, the UK’s Financial Reporting Council (FRC) is consulting on a new Stewardship Code that focuses on how effective stewardship can deliver sustainable value for beneficiaries, the economy and society, as well as setting substantially higher expectations for investor stewardship policy and practice.  As we can see, the instigus towards an increasing focus on ESG investing has become more and more prevalent. But how do these regulatory drivers actually translate into practice?

Given the fact there seems to be an ever-growing set of ESG strategies available in the marketplace, how does one go about selecting an ESG manager that can best fulfill these new requirements?

 

Incorporating ESG principles

The forthcoming EU regulations will affect asset managers in several ways, including the likely introduction of disclosure obligations on how both asset managers and institutional investors integrate environmental, social and governance (ESG) factors into their risk processes.  Furthermore, the FRC’s updated code will require UK fund managers to take ESG factors into far more serious consideration, dictating how asset managers hold their investee companies to account by reporting on their purpose, values and culture to help meet their client obligations.

Because there is no one-size-fits-all approach by managers to incorporate ESG principles into the investment process, Honor Fell, Head of Responsible Investment at leading independent investment consultant, Redington, recently reviewed the aspects that she looks for in an ESG manager at a recent ‘Reworking ESG’ thought leadership forum hosted by Style Analytics. Fell listed four main areas of consideration, including:

  • Integration into the investment process:  It has become clear over time that sustainable investing is much more effective when ESG factors are integrated into existing investment process, rather than carried out in parallel to the traditional investment process.  ESG factors should ideally be systematically and explicitly included in all processes and tools within an investment management firm.
  • Infrastructure:  Information provided by companies is not always consistent or reliable. Sustainability reports, which are unaudited, are often more about building corporate reputation than disciplined ESG reporting, meaning investors may wish to conduct their own assessments of companies’ ESG credentials and incorporate data derived from social media, AGM resolutions, tax policies, the benchmarking of company practices, and ESG risk ratings.  An asset manager should have the infrastructure in place to ensure that information on ESG factors is getting to the right people within the organisation;
  • Stewardship:  The manager should be willing to engage with regard to exercising shareholder power on behalf of members to work with companies on improving their ESG practices. Engagement can take the form of voting at shareholder meetings or discussing and working with companies on areas which need to be improved.  Moreover, this approach to stewardship can go beyond simply looking at equities and shareholder rights, but also involve an engagement with regards to property assets and fixed income holdings;
  • Accountability:  In order to ensure ESG is actually being integrated within an investment firm, further detailed qualitative research needs to be carried out with regard to, for example, what the C-suite is talking about, as well as face-to-face discussions with managers. The cultural alignment with ESG integration can then be benchmarked and compared over time.

 

The secret is in the data

Once a niche practice, sustainable investing has become a large and fast-growing major market segment. New ESG strategies have recently been developed which are designed to enhance returns, strengthen risk management, and help align sustainable investing strategies with the priorities of beneficiaries and stakeholders.  It is through the integration of ESG factors into the investment process, however, that investors can ensure results are not compromised. The secret to finding an ESG manager who not only integrates ESG factors, but has access to the right information, is willing to engage, and is accountable, lies in the ability to analyze in-depth data that cuts far past the promises of a slick ESG marketing slide.