Asset managers and ESG implementation: Turning regulatory and operational compliance into commercial opportunities

Asset managers have a pivotal role in financing the transition towards low-carbon economic systems. Hence, governments have introduced several ESG-related regulatory requirements that apply to asset managers. Some examples of these are the Sustainable Finance Disclosure Regulation (SFDR) in the EU and the mandatory disclosures in line with the Taskforce on Climate Financial Disclosures’ recommendations (TCFD) in the UK.

New ESG regulations applying to asset managers show no signs of abating, with the UK as one example, expecting to consult in the next six months on sustainable investment labels, a general anti-greenwashing rule, a green taxonomy and mandatory disclosures on transition plans, and reviewing the UK Stewardship Code.

As firms strive to embed these requirements throughout their business, it is essential that asset managers have practical insights on how to successfully navigate the complex and evolving ESG landscape, and also how they can use regulatory implementation to demonstrate ESG ambition whilst seizing new commercial opportunities.

The biggest operational challenges for asset management firms when embedding ESG requirements

The breadth of opportunities and risks posed by ESG means that it permeates the entirety of a firm’s operations. There are five operational areas where implementing ESG is having the largest impact on asset managers. If a firm can focus on successfully implementing the following areas, they can then use it as a springboard for commercial opportunities:

• Data – overwhelmingly the biggest challenge is how to collect, process and utilise the data required to identify, monitor, and manage ESG-related opportunities and risks, as well as satisfying regulatory reporting requirements. Strong data governance frameworks are as important for ESG data as they are for other business information. Firms should start embedding robust processes now, recognising that data needs will evolve as ESG data matures and quality improves.
• Investment process – embedding ESG into the investment decision making and governance processes. This necessitates incorporating and structuring ESG expertise and knowledge within investment teams so that firms can monitor sustainable investment characteristics and objectives against fund and portfolio constituents. This therefore allows for maintaining accurate identification and tracking of ESG risks.
• Reporting – understanding data lineage and data flows. Having robust reporting processes to ensure internal and external stakeholders receive the ESG-related information they need in appropriate formats (whether that is for fund reports to investors or ESG-related risk metrics to investment committees and senior management).
• Client communication – ensuring that all investor communications, documents, and channels contain the right material and contents to mitigate the risk of misrepresentation. Having the right data and reporting processes is the foundation for delivering this.
• Education – training employees on relevant ESG-related matters and tailoring content for staff-specific roles.

What investors’ ESG insights mean for ESG implementation and sustainability-related opportunities

The first ESG regulations have been in force for a couple of years, and we are obtaining insights on how investors view asset managers’ implementation of those regulations. Investors’ concerns, emanating from the introduction of the SFDR, surround those asset managers who have; i) downgraded funds from Article 9 to Article 8; and/or ii) changed strategies to satisfy SFDR criteria.

Investors are also showing concern around the structure and comprehension of some ESG regulations, and how asset managers have applied them. For example, there are very few passive funds in the Article 9 category. One reason being there is little-to-no engagement or stewardship activities with investee companies by such funds. Investors are also concerned about missing out on investees companies that are “transitioning to net zero” because of exclusionary screening criteria in Article 9 funds.

These insights indicate that asset managers must think carefully about how they create their ESG strategies and portfolios. They should be careful not to be lured by desirable labels at the expense of understanding and meeting investors’ preferences and generating long-term growth opportunities.

If firms embed some of the following ESG best practices, then they should be viewed positively by potential clients, enhance credibility, and build long-term commercial opportunities. Asset managers who do this will signal that ESG implementation is not restricted to regulatory compliance and that sustainability-related products are a long-term strategic proposition for their clients.

• Provide a suite of funds that have sustainable investing at its core.
• Ensure that the suite of sustainable investment opportunities expands beyond equities to all asset classes.
• Backing offerings with demonstrable evidence of expertise, resources, and capabilities across the asset management firm. Use the key operational areas mentioned in this article as foci to start that journey.
• Providing credible evidence of engagement activities with investee companies and issuers. ESG disclosures is a good way to do this.
• Going beyond the regulatory minimum to incorporate other mechanisms and frameworks that drive and signal a positive sustainability investment culture. Examples are designing internal ESG scoring methodologies and introducing carbon benchmarking to compare investee companies’ net-zero transitions.

Conclusion

Governments and regulatory authorities have introduced several ESG-related regulatory requirements in recent years. The ESG regulatory pipeline shows no signs of abating and regulatory oversight of firms’ ESG activities and implementation will only intensify. As firms strive to embed these requirements throughout their business, they should use this as an opportunity to look beyond minimum regulatory compliance and instead, embed operational improvements that broaden strategic opportunities. Firms can use these operational improvements to signal to the market their ESG ambition and establish new commercial opportunities that meet investors preferences.

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