Mark Gillan, Head of Product at AJ Bell Investments, reflects on some of the landmark initiatives which have hit the ESG headlines over the past few months and which have the potential to drive real change in investment and financial advice processes for the future.
Unless you’ve been on a strong media detox of late, you’re unlikely to have missed the fact that the 2021 United Nations Climate Change Conference, known as the COP26 summit, was held in Glasgow last November. It brought together heads of state, government leaders and important industry figures from nearly 200 nations. The main objectives of the conference were to restrict the level of global warming to 1.5 degrees Celsius above pre-industrial levels, and to achieve net-zero emissions by 2050.
The global finance industry has always been seen as an important factor in the drive to achieve climate change targets. Indeed, the COP26 meeting included a dedicated ‘finance day’ where key players from governments, central banks and business discussed how the industry could rise to meet the ambitious challenges of the conference.
Investment strategies where such values are taken into account, often known as Environmental, Social and Governance (ESG) investing, have been available for many years as advisers will know. However, they are now very well established as a strong market trend, with consumers around the world placing ever-larger amounts into ESG products.
A recent FCA survey indicated that 80% of respondents wanted their investment portfolios to “do some good” as well as providing them with a financial return, and 71% wanted to invest in a way that “is protecting the environment”.
Driving positive change
For their part, the UK authorities such as HM Treasury, the Bank of England and the Financial Conduct Authority (FCA) have been working on a number of initiatives in this arena.
On the COP26 finance day, the FCA published its strategy on ESG, indicating its desired outcomes and the actions needed to achieve them. The strategy codifies a number of items that the regulator has previously announced, with themes of transparency, trust, tools, transition, and team. The overarching objective is to support the financial sector to drive positive change, particularly in the transition to net zero emissions.
Changing the regulatory environment
One potentially important piece of work is the discussion paper published by the FCA on 3 November – Sustainability Disclosure Requirements and Investment Labels. The European Union’s Sustainable Finance Disclosure Regulation (SFDR) contains a variety of provisions, including an obligation for financial advisers to take into account the ESG/sustainability preferences of clients as part of the advice process. SFDR was not implemented into UK law prior to Brexit, but the FCA has now launched its own Sustainability Disclosure Requirements which will cover much of the same ground as SFDR would have done.
Although the discussion paper is centred around the investment management industry, financial advisers are also referenced as a critical part of the value chain. The FCA’s proposals for advisers are not fully fleshed out in its paper, but a clear steer is given, so advisers should pay keen attention to the regulator’s moves in this area: “…we recognise the important role that financial advisers play in providing consumers with sufficient information to assess which products meet their needs. We are also exploring how best to introduce specific sustainability related requirements for these firms and individuals. Building on existing rules, a key aim will be to confirm that they should take sustainability matters into account in their investment advice and understand investors’ preferences on sustainability to ensure their advice is suitable. We will develop proposals on this in due course, working with Government…”
Overcoming the barriers
One core problem associated with the area of ESG investing is that of labelling. The FCA has a concern that there is the potential for ‘greenwashing’, where sustainability claims made by investment management firms do not stand up to scrutiny. There is also a litany of different labels which can be confusing for investors and advisers looking for suitable products. These products can be variously labelled as ethical, ESG, SRI, responsible, green, impact and so on. With labels being an important driver of consumer choice, the FCA is looking to enhance trust in this area and develop a set of objective classifications for products. Its proposal is to classify them into five high-level categories, as follows:
- ‘Not promoted as sustainable’ – Here, sustainability risks have not been integrated into the investment philosophy of the product and there are no specific sustainability objectives.
- ‘Responsible’ – The impact of sustainability factors on risk and return has been considered. There should be a level of ESG integration into the product’s management, with evidence of ESG capabilities and resources from the manager, and demonstrable investment stewardship.
- ‘Sustainable – Transitioning’ – Products with sustainability characteristics, themes or objectives which do not yet have a substantial proportion of underlying assets that meet the sustainability criteria set out in the UK Taxonomy, but the expectation is that this proportion will rise over time.
- ‘Sustainable – Aligned’ – Products with sustainability characteristics, themes or objectives which have a substantial proportion of underlying assets that meet the sustainability criteria set out in the UK Taxonomy.
- ‘Sustainable Impact’ – Products with explicit objectives to deliver net positive social and/or environmental impact as well as a financial return.
Alongside these labels, the FCA has indicated its intention for firms to provide the most pertinent sustainability-related information via consumer-facing disclosure, in order for investors to be armed with all the information required for them to make a considered choice with their capital.
The FCA’s proposals are at a very early stage, but the direction of travel is fairly clear. ESG investment is growing at a rapid pace, driven by strong consumer demand and a significant push from regulators and governments around the world. In many ways, the sustainable investment sector remains somewhat fragmented and its labelling can be confusing for customers. With increasing choice from asset managers, and more advisers incorporating ESG products into their advice process to meet their clients’ preferences, the regulator’s moves to build trust make the industry clearer and more harmonised will be welcomed in many quarters.
About Mark Gillan
Mark studied Economics at Liverpool University, and has a master’s degree in International Banking & Finance from Liverpool John Moores University. Qualified to CISI Diploma level in Investment Operations, Mark came to AJ Bell with nine years’ experience in operations at a custodian and an investment management firm.
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