1. ESG regulations in the EU and the US
It will come as no surprise that the ever-changing sustainability regulations and frameworks were a major talking point at TSAM, including the Sustainable Finance Disclosure Regulation (SFDR), which becomes mandatory from January 2023.
The SFDR was introduced as a framework to improve transparency in the European market for sustainable investment products and to prevent greenwashing. Nowadays, it is used by many as a marketing label, distorting its intended purpose and creating industry-wide challenges (an issue that Dr Kay Swinburne, Vice Chair of Financial Services, KPMG, addressed in her keynote speech).
It’s attractive to classify funds as Articles 8 or 9 under the SFDR, but the utility of these labels is questionable. Varying interpretations of the technical criteria mean that the classification process has been largely left to the discretion of asset managers. This explains why different funds under the same classification could look drastically different.
With the SEC and FCA’s own versions of these regulations on the horizon, and existing regional standards like CERDS in China, the regulatory landscape is getting murkier, and further away from standardisation.
Gordon Tveito-Duncan (Co-Founder, GaiaLens) on a panel about ‘Measuring the true extent of ESG returns and performance’ at TSAM ESG 2022
2. ESG data challenges
Lack of standardisation, inconsistencies and outdated data create challenges that asset managers know all too well about. The discussions at TSAM provided an honest outlook for 2023.
Environment reporting is set to improve, due to the increasing pressure on corporates to disclose this data, and initiatives making it easier for them to do so (e.g. the CDP and TCFD). That being said, emerging markets, small-cap and private companies may be an exception to this for some time still.
Social data remains tricky due to the subjectivity of the data points. Many Social data points like employee satisfaction or community impact don’t tend to be reported by companies, to begin with.
There are fewer challenges with Governance data, as unlike environmental or social data, it has been compiled for a longer period of time and the criteria for what comprises good governance and its classification has been more widely discussed and accepted.
There’s a wide recognition that technology can provide solutions to these challenges as technology can help to:
(1) collect more data from a variety of underutilised sources e.g. NGOs
(2) NLP models can process high-quality ESG news at scale
As an asset manager, you’ll need both structured data (e.g. reported fines or levies) and unstructured data (e.g. news about the latest ESG scandals) to get the full picture.
3. The nuance of ESG
There are data challenges on the whole and then there are nuances within the data that you need to watch out for.
Take Tesla, for example. As one of the largest producers of electric cars, and solar panels in the US, Tesla should, in theory, have a high ESG rating. But with a poor record on labour issues and human capital, its low Social pillar score often brings down its overall ESG score.
It’s a reminder that even if a company’s product may be positioned as sustainable, the way they’re producing their products may not be. Tesla makes a product in line with climate goals, but the company has other operational issues that are of concern to ESG investors.
If impact investing is important to you and your investors, then it is paramount that nuances such as these are not overlooked.
Shell ranks higher than Tesla in data from MSCI
4. ESG performance & returns
We talked about how caring about ESG has become a luxury that not many companies can afford.
The looming recession, budget cuts, and a skills shortage means that many companies are fighting for survival and are worried about whether they’ll even have a business in the years ahead.
ESG isn’t their main focus, in fact, according to a KPMG study, 50% of CEOs surveyed are pausing or discontinuing existing or planned ESG efforts. Roughly a third have already done so.
This would mean that asset managers have less to go by on. However, their primary concerns will be around making investments that yield maximum returns.
With the economic downturn, it will continue to be increasingly important to marry up reliable ESG data with investments that will help asset managers hit your bottom lines.
5. Rise of transitional assets
Baby Boomers remain the most represented demographic in asset management, but this will change soon as a younger, more climate-conscious generation starts managing large funds.
PwC’s research suggests institutional investors in Europe today expect ESG and non-ESG products to converge and, from next year, 77% of these institutions are expected to stop investing in the latter. ESG fund assets under management may account for more than 50% of mutual fund assets by 2025.
Asset managers should take that to mean that ESG investing is here to stay, along with the ongoing conversations around ESG data challenges, regulation, and marketing - which we all need to get better at having, and finding solutions for.