A rise in ESG reporting requirements is impacting asset managers in every conceivable way. The solution, discovers Nicholas Pratt, is to use all of this newly found data to form a closer relationship with the next generation of investors.

The rise of sustainable investment and ESG reporting is the greatest test yet of asset managers’ role in society. The introduction of regulations such as the EU’s Sustainable Finance Disclosure Regime (SFDR) will primarily have a sizeable impact on firms’ operational and administrative functions.

It will also affect the relationship between an asset manager and its end investors regarding how firms develop ESG products to match their clients’ preferences and how the cost of additional reporting is shared between investors and managers.

And then, there is the relationship between asset managers and the companies they invest in. As greater attention is placed on companies’ ESG impact, asset managers will be under pressure to either increase their corporate engagement or to divest from those companies that do not meet the ESG preferences of their end investors.

All of these issues were discussed in a webinar held by Funds Europe, in partnership with Fundsquare, in late June.

Europe can justifiably claim to be the leading jurisdiction for ESG at present. With the SFDR and other related initiatives, such as the Non-Financial Reporting Directive and the EU Action Plan on Sustainable Finance, which were introduced in 2014 and 2018, respectively, it has been a first mover in regulatory reporting terms.

“Europe was the first to develop an ESG reporting framework that has been closely examined and widely accepted,” said Tanya Petridou, head of information services at investment data platform Fundsquare.

The EU has also developed the European ESG Template, which Petridou described as the “golden source for all sustainability-related data” and something likely to be adopted by other jurisdictions.

This gives EU firms an advantage in that they have been able to develop their own reporting processes knowing what is required of them, said Petridou.

This leading role has been reflected in the number of ESG funds established and domiciled in the EU, which has grown rapidly and now accounts for roughly 80% of global assets under management within the ESG market.

However, while other jurisdictions such as the US, the UK and Asia are looking at the EU’s framework, there is no guarantee that they will follow it and not choose to pursue their own taxonomy and reporting requirements.

As Oriane Schoonbroodt, director of sustainability and sustainable finance at PwC, said: “European asset managers have to be careful because the regulation is very complex, and it is difficult for people to understand what they have to do and how they have to do it. Other jurisdictions may produce more streamlined and effective regulations.”

Absence of standards
The other fear is that if jurisdictions depart too much from the European approach, we will end up with an inconsistent regulatory environment and an absence of reporting standards, adding to an already heavy administrative load.

There are initiatives underway to try and address this, including the International Sustainability Standards Board (ISSB). “It is a noble objective, but it is a hard one to achieve,” said Julien Renkin, chief commercial officer at Belgium-based fintech Sopiad.

He pointed to the example of other more mature investment sectors where there is still an absence of a single global standard, but the market functions well enough regardless.

Schoonbroodt also highlighted that the ISSB is a private initiative with a strong US influence, which may end up competing with the EU’s Corporate Sustainability Reporting Directive unless some collaboration can be achieved.

One of the overall objectives of the SFDR and other related regulations is to limit the instances of greenwashing, which will require data availability and expertise to analyse the data.

However, said Petridou, this has led to concerns from asset managers about the cost of meeting requirements – not just in terms of system changes but also in staff recruitment and the number of resources dedicated to ESG data management and reporting.

With every challenge comes an opportunity, she added, and there is a chance to bolster the relationship between asset managers and their clients and improve education and reduce the complexity.

The key, said Renkin, was to use the reporting process not just as a box-ticking exercise but as a way to inform product development. This should become a more straightforward exercise in Europe as we see the introduction of client preferences.

Up to now, the reporting requirements have centred on the products. The next stage is to match up those products with investors’ ESG preferences via principal adverse impact statements and materiality data.

However, Schoonbroodt said that while there are clear long-term benefits to be had, there is some significant short-term complexity to overcome first. “It’s still really difficult to understand what kind of data we need – the definition of materiality is different from one company to another and from one investor to another.”

In essence, said Schoonbroodt, it is about balancing the need for standards so that investors can make fair comparisons while retaining enough flexibility to cater to investors’ subjective preferences.

In terms of the relationship between asset managers and their portfolio companies, it comes down to divestment versus engagement. The demand for extra corporate disclosure is there, said Renkin, but so are investors’ demands for more transparency around asset managers’ engagement with companies.

He said that ESG data providers are already seeing an improvement in asset managers’ transparency around their engagement and disclosure of information that is leaner and more accurate than ever before.

Ultimately, said Petridou, the intention of regulators is to encourage a shift of capital from unsustainable to sustainable companies. Consequently, engagement will become increasingly important.

And, as Schoonbroodt said, we are still at an early stage in the ESG market, so there is likely to be more engagement than divestment. However, in order to retain some credibility, it is essential that there is more transparency around engagement and that it is not simply being used as a way to avoid divestment.

Generational values

The panellists also discussed the generational issue within the ESG world in both an asset manager context and also the end investors. As Renkin said, we are about to witness the biggest intergenerational transfer of wealth in history to a new set of investors with different values.

“The younger the investor, the higher the demand is for sustainable investment products,” Renkin added.

“Many of the current investors may not be particularly interested in ESG, but all the research shows that the next generation of investors will be much more focused on ESG. The journey is long, so if firms want to prepare for the next generation, the sooner they start this journey, the better.”

Listen to the ‘Measuring and Managing the Impact of ESG’ webinar here.

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