The strategy around Environmental, Social, and Governance (ESG) across the industry has moved beyond PowerPoint decks and coffee machine chats – it is now driving industry objectives, shaping business strategies, and revealing new revenue opportunities. Simultaneously, various ESG-focused regulations are taking shape, and firms are under pressure to act fast due to swiftly evolving requirements.
In this article, we discuss why current and aspiring mainstream financial services providers cannot ignore the opportunities that ESG is bringing as well as the regulatory awareness required to create successful business strategies and ensure organisational compliance.
The ESG Market is hot – if you’re not in it – you’re already late.
Green investments and assets are gaining popularity
Last year, inflows into impact investing increased by £7.1bn (a rise of 275% compared to 2019)1 and climate-focused ETF’s comprised 25% of all European ETF’s2. Gen X demographics contributed to this trend via their exposure to righteous social media cues. And they are set to inherit billions, thus signalling an exciting revenue opportunity for Wealth Managers. To top it all off, Morningstar highlight that Impact Investing is not limited to this age group. All demographics are showing an interest3.
Sustainable financing is emerging
In the next four years, trade finance could grow by $11.25bn4, heralding an opportunity for corporate lenders and investment banks. Lenders are offering lower rates to suppliers that meet a pre-defined ESG target, which should encourage virtuous behaviour amongst small industries to further facilitate a sustainable procurement network.
Business and brand benefits of pursuing ESG agendas
Firms trying to commit themselves to various domestic and international ESG guidelines such as the Paris Agreement, ‘net carbon zero’ or the Green Finance Strategy are also seeing huge commercial advantages in the market such as increased clientele, better retention, and an overall stronger brand image.
There are real consequences of not focusing on ESG strategies, including loss of business.
Last year, Scottish Widows divested £440 million from funds that did not meet their own ESG standards5. Many large global firms have also added ESG criteria to select their suppliers and distributors.
Moreover, going forward, credit risk methodologies are expected to include ESG criteria. While it may not yet be reflected precisely in policy, banks certainly consider sustainability a key factor when making lending assessments.
Becoming ESG ‘Regulatory Wise’ early will be key for firms
To pursue any ESG strategy effectively, firms will be faced with compliance demands from multiple evolving ESG regulations across the globe that cover everything from governance to disclosure requirements. We discuss specifics around critical topics impacting the European and UK markets.
The EU Taxonomy
The EU Taxonomy is a framework to classify whether products are ‘sustainable’ to better lessen the likelihood of greenwashing attempts. According to a set of pre-defined indicators for alignment, investments must both ‘promote an environmental or social characteristic’ and ‘do no significant harm to any other area of environmental or social concern.’ The delegated acts are set to be published in June 2021 and will supplement the Sustainable Finance Disclosure Regulation, where firms must disclose details of how financial products have a ‘sustainable’ objective – the first compliance date is January 2022. The EU Taxonomy will also sit parallel to the Non-Financial Reporting Directive.
Non-Financial Reporting Directive (NFRD)
On February 20th 2020, the European Commission published a consultation regarding changes to NFRD – with the aim to enhance the quality and quantity of environmental and social data, which is currently disclosed by large EU public corporates. On March 1st, ESMA published their final report with a proposal for disclosure requirements to support in-scope firms on how they should classify their KPI’s as ‘sustainable’ – as per the EU taxonomy.
Sustainable Finance Disclosure Regulation (SFDR)
Asset managers must disclose, on a manager and product level, how they incorporate sustainability risks into their investment decisions. SFDR entered into force on March 10th, 2021 , and asset managers were required to provide information on sustainability risks on their website and via a pre-contractual disclosure. A ‘principal adverse impact’ statement was also required, which is intended to detail the impact of investment decisions on sustainability factors. Firms with 500+ employees have until June 30th, 2021 to submit this.
Further disclosures are expected to apply on January 1st, 2022, following the publication of the European Supervisory Authorities’ final report and the draft Regulatory Technical Standards (RTS). This was welcomed by the industry as it provides further clarity over methodology and compliance expectations. Asset managers should pay close attention to further updates regarding the application of the final RTS and engage with data providers to determine how sustainability risks impact their investment decisions.
Task Force on Climate-Related Financial Disclosures (TCFD) Reporting
UK regulators are taking an overt role to create a systemic ESG reporting mechanism. The FCA has ruled that UK Listed Companies, including asset managers, must state whether their disclosures align with TCFD’s framework – the deadline is Q2 2022, but many are already preparing for implementation ahead of that.
The Chancellor has also announced that TCFD disclosures will be mandatory across the whole economy by 2025, in line with the UK’s Green Finance Strategy.
The Bank of England’s Biennial Exploratory Scenario (CBES) will launch in June 2021. Banks and insurers will need to stress test on a counterparty-level to assess their exposure to climate-related risks by the end of September. Modelling will cover a 30-year period to account for the unpredictability and moderate development of climate change.
Amendments to MIFID II, UCITS and AIFMD
Amendments to these regulations will supplement SFDR disclosures and will focus on organisational and governance structures, investment due diligence, client suitability assessments, and product marketing strategies. Essentially, clients’ ESG preferences must be reflected in any investment advisory practice or marketing strategy. These changes are likely to apply in Q3 this year.
How can Delta Capita help?
Delta Capita’s regulatory experts have been following the evolution of ESG investments over the years and are well placed to help you navigate the shifting regulatory landscape. We are plugged into multiple industry conversations and are a part of industry working groups. We will always be able to provide you with the latest and greatest information.
FinTech tools to support ESG objectives
Delta Capita has a unique combination of deep consulting experience as well as an extensive proprietary tech and a broader fintech ecosystem. Our partners can further enhance and support ongoing ESG objectives, including utilising our NLP sentiment tool ‘Revuze’ to detect whether any ESG activities are being perceived as ‘Greenwashing’.
Operational Due Diligence Team
Our fund operational due diligence services have already helped many clients identify the extent to which investment managers are addressing ESG related matters. This can be a broad remit, but the essentials would include policy and strategy, investment approach, training, professional memberships, environmental sustainability, social and diversity frameworks as well as any adverse workplace litigation.
Know Your Supplier and Distributor
Our market-leading platform, Karbon, can help clients include ESG metrics within their KYS and KYD requirements and processes.
Get in touch with us for more information or to speak to one of our experts.
Contributors: Karan Kapoor, Clementine Elcock, Sarah Carver, James Newman, Gary McClure