Where are you in your ESG investing journey? Here’s how to get ahead

April 02 2020

Michaela RizzoPension & Insurance Solutions

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Caroline HaasManaging Director and Head of Sustainable Finance, Financial Institutions and SSAs

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8 minute read

Whether you’re an institutional investor, an issuer or an asset owner, here are some considerations for incorporating ESG factors and recent market updates.

ESG investing: It’s not about the name it’s about the goal

ESG (Environmental, Social and Governance), Responsible Investing or Sustainable Finance?  Rather than getting bogged down by definitions, all three terms have a common goal. They are aimed at trying to:

1) Bring a longer-term perspective across the entire financial services food chain; and

2) Consider (often qualitatively) wider externalities, including climate change.

Whether it’s primary issuance from companies or investments by asset managers and asset owners – ESG is an area which permeates them all. Whilst banks have in recent years established a precedent of facilitating the issuance of green bonds and more recently social and Sustainable Development Goals (‘SDG’) related bonds, the industry has taken strides to embed sustainable finance to the whole value chain in financial services.

Connecting asset managers with issuers is one feedback loop we are actively encouraging. We’re also working to ensure continuous ESG feedback is considered alongside more traditional capacity and pricing considerations, enabling corporate financing plans to be updated accordingly. We advocate engagement rather than divestment, particularly for issuers in carbon-intensive sectors such as oil and gas, and are working with clients to support them as they tackle carbon related goals.

We advocate engagement rather than divestment, particularly for issuers in carbon-intensive sectors such as oil and gas

Regulatory developments in ESG have turned the dial…

…especially for pension schemes

Ultimately, it is the asset owners who have seen increasingly changing trends in recent years, and increased focus on stewardship and carbon reporting across the world.

Defined Benefit (‘DB’) pension schemes for example, that amount to over £1.6 trillion[1] of assets in the UK, have seen increased awareness and regulatory developments of such issues. This has prompted many to reconsider how they integrate ESG factors into diversified portfolios. The updated Financial Reporting Council’s (FRC) Stewardship Code 2020[2] is one recent example where there has been significant change, increasing the expectation around how stewardship is integrated across asset classes, including ESG issues. This follows ample developments across Europe in this space; in Germany, the regulator (BaFin) has recently issued guidance on dealing with sustainability and ESG risks, including physical and transition risks for any entity that they regulate.[3] Prior developments include Article 173 of the French Energy Transition Law[4] which strengthened mandatory carbon disclosure requirements and Article 135(4) of the Pensions Act in the Netherlands[5], which ensures pension schemes include an explanation of how they take into account the environment and climate, human rights and social relationships. Just these few examples across Europe show the range and increased regulatory intervention in this space.

In practice, implementing strategies that adhere to such guidance remains complicated, as many asset classes lack adequate data or disclosures, such as for private market assets.  For pension schemes specifically, many trustees now consider this in different ways that are appropriate for the scheme’s circumstances and time horizon, rather than relying on more established positive/negative screenings on investments, which are more common for many European pension schemes.

Deeper analysis on climate change is required

Whilst many portfolio managers now consider environmental (‘E’), social (‘S’) and governance (‘G’) factors as being part of fundamental credit analysis, data is needed across all asset classes - going beyond equity and fixed income  – albeit that’s where most progress has been to date. Indeed, an increasing amount of academic research is showing that ESG integration can lead to financial outperformance and that suitable integration is needed across all asset classes (not just equity and fixed income).  Climate change is one subset of ESG factors, which many regulators have carved out for consideration, although it remains unclear as to how this will be consistently applied.

In 2015, the countries involved with the United Nations Framework Convention on Climate Change agreed in Paris to target limiting global warming to significantly below 2°C, and to pursue efforts to limit warming to 1.5°C. Whether it be this Agreement or a range of recent macro-political developments that surround this issue, one consideration for readers is the extent to which an institution commits to explicit climate related targets rather than ESG factors broadly. In January, the shareholder resolution at Barclays is one example whereby an institution is formally being asked to phase out its financing of fossil fuel companies, which is not aligned with the goals of the Paris Climate Agreement. One thing is for sure; investors are watching.

Whether it be this Agreement or a range of recent macro-political developments that surround this issue, one consideration for readers is the extent to which an institution commits to explicit climate related targets rather than ESG factors broadly.

Climate-related stress tests are just a start

Climate change scenario testing has been one avenue that some asset owners have explored, although like any long-term modelling assumptions, the funnel of doubt is substantial. UK insurance companies in 2019 have started using the Prudential Regulation Authority’s (PRA) climate change stress tests, whereas banks will be expected to submit their findings in 2021. All these aspects combined show myriad ways the financial sector is embracing climate change – continued work, resources and coordination between peers is needed to ensure ESG or climate specific comparability. For an area which is still being labelled by some generically as ‘green’ with ample green washing, the regulatory pushes and asset owner preferences are ultimately changing the entire investment landscape. We’re pushing for more disclosure, collaboration and clarity; however, the direction of travel is only one way.

So what can you do to get ahead in your ESG investing journey?

ESG steps for asset owners
  • Outside of those explicitly targeting a qualitative objective (e.g. impacting investing), many asset owners will always prioritise financial performance, hence ESG considerations have to be overlaid on that fundamental objective.
  • For UK pension schemes, it is the trustees’ fiduciary responsibility to prioritise pension payments as they fall due, with the latest pension regulations stating that financially material considerations now include (but are not limited to) ESG factors, including climate change.
  • Combined with available and relevant ESG data provision in this space, asset owners need to look at how they meet ESG related goals e.g. a limit on carbon exposure, which is integrated into their investment strategy (which in turn is often outsourced to asset managers). With increasing public disclosure required by the asset owners, the scrutiny on methods and implementation is likely to increase in the next couple of years.
  • Use one’s voting power, whether it be proxy voting or more active engagement – this is part of the stewardship role that asset owners are increasingly being asked about and dependent on your governance model, is particularly important in both equities and fixed income.
  • The increased use of ESG data provision has in part been fuelled by asset owners seeking to better understand their portfolio using the lens of responsible investing. Data providers should be leading to extend their coverage across asset classes so that once asset owners better understand their risks and exposures, they’ll be better positioned to make decisions.
ESG steps for issuers
  • Ensure investor relations teams/those on investor roadshows are fully up to speed on ESG related questions important to asset managers and be clear on disclosures such as Task Force on Climate-related Financial Disclosures (TCFD) or other equivalent reporting.
  • Be able to highlight the importance of your organisation’s sustainability strategy and how it is meaningfully integrates into the business decisions. Obtain as much feedback as possible from asset managers and investors on questions around ESG, particularly if the corporate is in an carbon-intensive or controversial sector.
  • Consider adding an ESG section to your debt programme (e.g. medium-term note (MTN) documentation[6]).
  • Keep up to date with the latest market developments such as transition bonds.
  • Consider the inclusion of ambitious climate related targets, such as committing to making your own operations net carbon zero by 20XX and/or climate positive by 20XX (the sooner, the better of course!)
ESG steps for asset managers
  • Be as transparent as possible and ensure there is a coordinated effort between ESG specialists, credit analysts and the underlying portfolio managers. This is in addition to coordinating with the organisation’s marketing team, to ensure there is a holistic and authentic approach.
  • This is an increasingly important issue for asset owners but being open around what you currently do and what changes are explicitly in-train is helpful – too often when pitching for new asset management mandates is the ESG policy mentioned but not evidenced, or limited to a specific ESG related fund (or ESG specialist) only
  • Asset managers, particularly those that are responsible for private assets which are more difficult to quantify in terms of ESG characteristics, will be critically important in developing consistent industry-wide methodologies to support asset owners’ intent to meet their stewardship objectives.
  • Recognition of the critical role asset managers will play in helping align capital with supra-national targets like the Paris Agreement, and consideration of committing to reducing the climate impact of your financing activity by a specified date in the foreseeable future.
  • Consideration for mapping the carbon exposure of your investments and using that to either reduce exposures, or construct portfolios that are aligned with a [X]oC change in global warming temperatures.

ESG investing: There is no turning back

Although this ‘new paradigm’ is daunting for all participants, momentum has built to such a point that there is no turning back. Along the complete financial markets supply chain from the underlying beneficiaries of pension schemes to asset owners and asset managers, combined with regulatory support, there is a lot of brain power and financial investment being made to find workable solutions.

We are very much looking forward to supporting this evolution for all of our clients, issuers, asset managers and asset owners.

[1] https://www.gov.uk/government/news/radical-shake-up-of-advice-to-pension-schemes-will-benefit-savers-and-boost-1-6-trillion-pension-assets

[2] https://www.frc.org.uk/investors/uk-stewardship-code


[4] https://www.unepfi.org/fileadmin/documents/PRI-FrenchEnergyTransitionLaw.pdf

[5] https://www.pensioenfederatie.nl/cms/streambin.aspx?documentid=4570 

[6] Medium-term note (‘MTN’) is a common form of debt financing 

Climate change
Asset management
Asset owners
Defined benefit pension schemes
Issuers corporate
ESG investing


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