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ESG regs – don’t delay the inevitable

December 2020

Before the Covid-19 crisis, the biggest potential disruptors on advisers’ radars were probably Brexit, and a raft of new regulations around sustainable investing. Even with the pandemic, neither of these issues have completely gone away. Brexit is upon us. And while MiFID II amendments, scheduled for March 2021, won’t go ahead in the UK in the planned timescales, it doesn’t mean advisers can take their eye of the regulatory ball. Here we explain why and provide some practical steps advisers can take now, to get ESG-ready.

Buying time?

Of all the new sustainable investing regulations, the amendments to MiFID II would probably have had the most significant impact on advisers. These largely focus on making it mandatory to consider your clients’ ESG – environmental, social and governance – preferences. Although this looming EU deadline is now gone for UK advisers, the implementation of a similar regime here is highly likely. Indeed, the FCA is set to commence consultation on this very topic in early 2021.

Many UK advice firms had already integrated ESG into their investment governance and client-suitability processes, in readiness for the Q1 2021 MiFID deadline. And we believe it makes sense for them to continue to develop these ESG-related business practices. While news of the delay may provide short-term relief for some, it could also be seen as an opportunity to position for what is coming.

The direction of travel

As we’ve covered in previous articles, client demand for sustainable investing is rising. This is partly driven by people’s growing awareness of the many environmental and social challenges the world faces. The Covid-19 crisis has only exacerbated this. As a result, many feel compelled to invest responsibly and use their money in a way that can help tackle these issues.

Then of course, there’s the potential financial impact that taking ESG factors into account can have on returns. Evidence of positive investment outcomes is helping to challenge the historic belief that investing sustainably means compromising on performance. With more sustainable solutions coming to the market every day, many of your clients will want the opportunity to invest in this way. Understandably, this shift in the industry is being met by greater regulatory scrutiny and legislation.

Get your ‘green’ house in order

Given this direction of travel, it makes good business sense for advisers to continue to prepare for regulatory rigour around this rapidly evolving trend.

A good starting point is to review how you currently integrate ESG principles into your proposition, and how you reflect these in your firm’s goals and philosophy. Consider your firm’s House View on responsible and sustainable investing and review your centralised investment proposition (CIP).

  • Does it go far enough to capture, document and match client-specific ESG-investing preferences with the investment portfolio?
  • Do you need to introduce a more detailed client questionnaire into your suitability process?
  • Is there a gap in your clients’ education that you could fill? You can help them make more informed choices by explaining the different types of responsible and sustainable investing and entry points?
  • Think about whether outsourcing to an ESG-specialist discretionary fund manager (DFM) might be better use of your time and resources. Doing so could help you meet your clients’ diverse requirements and mitigate investment and regulatory risk.

From here, you can build a documented House View. This could stipulate:

  • the different responsible investing options you’ll provide,
  • how you’ll capture your clients’ responsible investing values and what you’ll do if a client has very specific preferences
  • how frequently you’ll discuss their responsible investing views
  • the questionnaire you’ll use to uncover their preferences and values.

Once you’ve considered these points, you may want to build a responsible investment service and proposition, separate from your CIP. This may make use of specific responsible investment funds and portfolios. Or you could align with an active discretionary fund manager (DFM) that embeds ESG considerations in its decision-making process.

Do your due diligence

If you already outsource to a DFM, or are thinking of doing so, you also need to consider their ESG-investing credentials. In particular, look for evidence on how they integrate ESG factors. Here are some pointers to help ascertain your DFM’s approach.

Is your DFM a long-term investor?

Check if they focus on strategies that will drive long-term sustainability and fundamental value of the businesses they invest in. Broadly speaking, long-term investors are more likely to factor in ESG risks.

Does your DFM actively engage with the companies in which it invests?

It’s important to know how closely and frequently your fund managers interact with investee companies. Active and regular corporate engagement can lead to greater understanding and better assessment of the ESG risks and opportunities of an investment. And ultimately, better returns for your clients.

Is there evidence of engagement and ESG research driving investment decisions?

Can your DFM point to investments made/not made on the basis of ESG insights? It’s important that your DFM isn’t just undertaking worthy research, but actually factoring in ESG criteria in investment decisions.

Is your DFM a signatory to any major global agreements?

If a DFM is serious about its ESG responsibilities, they will likely be signatories of agreements like the UN PRI (Principles of Responsible Investing) and UN Global Compact.

What ESG ratings and scoring does your DFM use?

As regulators introduce more measures to combat ‘greenwashing’, you’ll need clear evidence of how you conduct your research and the sources of your data.

Do you have access to your DFM’s voting record and stewardship policy?

Try to partner with a DFM that publishes how they voted at company meetings and their engagement efforts. For example, does it make publicly available the number of companies it actively engages with and the results of its engagement efforts?

Final thoughts …

While MiFID II amendments might be on pause for now, greater regulatory scrutiny around sustainable investing seems certain. Don’t use the delay as a reason to put off the inevitable. Instead, use this extra time to prepare your policies and processes for a future in which sustainable investing will feature prominently.

Click on the links to read previous articles in our sustainable investing series

Or visit aberdeenstandardcapital.com/sustainable

To find out more, please get in touch with your usual contact at Aberdeen Standard Capital. You can also email us at asc@aberdeenstandard.com

Investment involves risk. The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested.

Warning

Investment involves risk. - The value of investments, and the income from them, can go down as well as up and an investor may get back less than the amount invested. Past performance is not a guide to future results.