Good due diligence now includes ESG and sustainable metrics

by | May 4, 2022

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In his latest article for IFA Magazine, ESG Accord’s Lee Coates OBE outlines what good looks like when it comes to an effective compliance framework that advisers can use to assess ESG and Sustainable Finance options.

Alongside the ‘usual’ set of measurements for due diligence and assessing funds, advisers must now define and integrate ESG and Sustainable Finance metrics. This brings challenges for researchers and paraplanners. Let me explain.

First, understanding that the fund universe now contains ESG and Sustainable options. But how do you know what to ask the Fund Managers?


Second, understanding target markets are based on the fund universe and this now contains ESG and Sustainable offerings, including those not directly marketed as ‘green’. How do you map a client’s ESG and Sustainable preferences and objectives across to your due diligence or vice versa?

The answer is a joined-up compliance process that covers the full spectrum of funds.

The Due Diligence options described below are part of the compliance framework we provide for advice firms. This has been thoroughly industry tested and helped inform our recently published ESG and Sustainable MPS Report (see later).


Questions and levelling up

Below I have outlined an abridged summary of what we believe best practice DD questions should look like:

General Questions: establish the base level of information required. Need to reference FCA Guiding Principles for Authorised ESG & Sustainable Investment Funds. The questions broadly cover ESG-related claims, marketing, management and are the fundamentals needed so that advisers and consumers can make informed choices (including MiFID II requirements – target market etc).


Level 0: For funds not marketed as ESG/Sustainable. Where the manager deems ESG financially relevant as risk management tool, how is this achieved and why? Where the fund/house does not consider ESG & sustainability risks relevant in the investment decisions, what are the reasons for excluding ESG?

Level 1: ESG. For funds marketed as having simple ESG credentials. Which metrics are used, how and why? What scoring systems are used and why? This ‘basic’ level’ would allow, for example, ESG scored controversial weapons and tobacco.

Level 2: ESG+. Differentiated from Level 1 ESG by applying filters, such as not including controversial weapons or tobacco. The process is deeper and perhaps extended across multiple funds or all equity funds. If filters are applied, what are they and how are they used in the investment process?


Level 3: Funds with a responsible investment process, combining positive investment with some limited avoidance criteria. Where funds apply sustainable themes with some responsible negative exclusions, what are the exclusions, what are the sustainable investment strategies, are any themes applied etc? How does the fund identify ESG related risks and opportunities?

Level 4: Sustainable Development Goals & Impact Investing. Are SDGs being used as a positive investment strategy, or is the investment process passed through a final SDG screen to identify any alignment? Does the fund have an Impact Investing strategy? If Yes, how is it applied, what framework is used and where is it applied in the investment process?

Level 5: Full ethical investment strategy, where a negative screen is applied, excluding sectors/companies involved in specific activities. A positive screen may also be applied, perhaps incorporating Responsible, SDGs or Impact strategies. Due diligence needs to capture all aspects of the exclusions and any positive focus.


Engagement: This is one of the best and worst aspects of Sustainable Investment. Done well, engagement can help to change corporate behaviour for the better, thus enhancing the whole E, S, and G. Done poorly it is used as an excuse by fund managers to buy whatever stock they want and then justify the investments by saying they are ‘engaging’. Each manager needs to be questioned in detail to assess whether they are truly operating engagement strategies that you can communicate to your clients, or whether it is a marketing exercise that clients will be less than impressed with.

Engagement can also be described as ‘transitioning’. A transitioning investment strategy can link well to the government’s broader plans for a transitioning society. The UK economy is on a path to Net Zero and a transitioning economy is a critical part of this. Fund Management groups adopting a well-documented, transparent and effective engagement/transition process will underpin the government’s strategy, and many clients will be supportive of these managers. Good due diligence on this subject is, therefore, essential.

Do you recommend MPS?


If you recommend MPS, and in particular ESG and Sustainable MPS, the due diligence outlined above will be needed. You’ll be pleased to note that we’ve done all of the leg work for you. On 31 March we launched our ESG and Sustainable MPS Report, and it is free for advisers to access online. You can register for access HERE


About ESG Accord

Lee Coates OBE is Co-Director at ESG Accord and further information on our Compliance Framework can be found here.


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