Sustainable investment in the spotlight: what asset managers should look out for

12 August 2019

Sustainable investing is attracting unprecedented levels of attention from regulators, both domestically and internationally. With an increasing public appetite for investments which generate a positive social impact and sustainable returns, the associated regulatory environment comes with new challenges for asset managers. But what are the main issues firms should look out for, and how should they respond?

There are three challenges in particular that asset managers should watch out for. Firstly, some firms have been struggling to navigate the wide-ranging and rapidly evolving regulatory initiatives in this space. This includes the revised EU Shareholder Rights Directive, the Financial Reporting Council’s revised Stewardship Code (the Code), and the EU’s Environmental, Social and Governance (ESG) disclosure regulation. 

Firms are having to juggle subtle differences in what is being asked of them in relation to the integration and disclosure of sustainability considerations into investment decision-making, alongside issues created by mismatched implementation deadlines. As it stands, firms should comply with the Code by December 2019, which is far sooner than the expected implementation deadline of October 2020 for the ESG disclosure regulation (one year after it is due to be published in the Official Journal). Even so, the 12-month implementation period appears ambitious and poses further challenges for firms, leaving only a short window for ESMA technical standards. Firms may be forced to comply with the new regulations before the technical standards have been finalised. The more advanced asset managers are likely to  respond to these initiatives by taking a holistic approach, seeking to establish a single solution capable of addressing related requirements across each piece of regulation. Firms must also ensure such an approach can be readily adapted as further regulatory clarity emerges.

Asset managers are also grappling with ESG data requirements. High quality data is necessary to help firms make judgements on what constitutes ESG activity for the purposes of meeting their regulatory obligations. However, the company data on ESG that is currently available in the market is often problematic, presented in awkward and inconsistent formats that are not readily comparable, which can lead to the publication of inconsistent data on the same companies by different providers. The recommendations of the Taskforce on Climate-related Financial Disclosures related to company disclosure of climate risk should address some problems around environmental data. The EU sustainability taxonomy, which intends to establish a common language for the industry, also has the potential to support firms with judgements around companies’ ESG credentials, though this has not yet reached political agreement, leaving firms lacking much-needed clarity. In any case, as it currently stands, both initiatives only address activity that is environmentally sustainable; this does not help firms deal with their assessments on the social and governance credentials of investee companies.

The final challenge stems from the industry perception that the regulatory agenda in this area carries an expectation that firms must also establish explicit sustainable investment strategies. Some fund managers are concerned that committing to sustainable investment strategies on this basis could lead to underperformance due to the reduction in eligible investment opportunities. Investors will have a range of needs and preferences when it comes to their portfolios, and many can still be expected to prioritise high-performing funds over those with an explicit sustainability strategy. Firms will need to manage this tension and ensure they continue to offer a broad range of investment strategies in order to uphold their fiduciary duty to act in their clients’ best interests.

But the new regulatory landscape also creates significant opportunities for asset managers. There is, in fact, evidence to suggest that sustainable investment strategies can create positive long-term returns for investors. By seeking out companies with strong ESG credentials, fund managers may generate more durable returns, mitigate risk and ultimately become more profitable over the long term. Firms that are able to adapt their business models to offer products with an explicit sustainable investment strategy, and balance this with their fiduciary duties to generate long-term returns, will reap the rewards. After all, it seems clear that sustainable investing will continue to remain in the spotlight, and how firms act now is likely to determine their success for decades to come

Lucas Penfold

Lucas Penfold | Manager
Profile | Email |  +44 (0)7483 407581

Leo Donnachie | Senior Associate
Profile | Email |  +44 (0)7483 329595

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