With governments and citizen activists demanding advancements in sustainable business, ESG initiatives are moving to the forefront of today’s market economy. In this environment, it is crucial for financial institutions to effectively manage ESG-related risks and capture ESG-centric opportunities as we see numerous examples in various domains of the financial services and insurance industries.
ESG investing has emerged as a leading driver of change in the wealth and asset management (WAM) industry. It has influenced practically all segments of the value chain, from investment analysis to product distribution, fund selection, manager due diligence, and financial advice.1 At the same time, it holds important implications for risk mitigation, asset pricing, and shareholder returns.
From the attention paid to 2016’s Paris Agreement to 2021’s United Nations Climate Change Conference in Glasgow, ESG has come to mean much more than Greenhouse Gas emissions (GHG). For example, “E” in the ESG also includes natural resources issues and investment opportunities like climate technologies, clean technologies, green building, renewable energy, etc. WAM firms should understand the exposure of their investments, which is exponentially trickier to monitor and more potent in driving change.
Extraordinary demand from institutional and retail clients has supported the rapid growth of responsible, sustainable, and impact investment funds. Global assets in dedicated ESG mutual funds and exchange-traded funds (ETFs) surpassed $1.3 trillion in June 2020. The U.S. market has witnessed the fastest growth, with assets rising to $185 billion. Net flows to long-term responsible funds quadrupled in 2019 to $20 billion, and then accelerated further during the first half of 2020 to reach $21 billion. Together, active and passive ESG strategies set a record in the first quarter that was matched in the second, despite the financial and economic shocks of the COVID-19 pandemic during 2020.
Each subsector in the WAM industry has its own structural issues and operational complexity, which might drive the transactional speeds and reporting requirements, forcing WAM managers to think of how to address these challenges consistently. Mutual funds present an array of revenue opportunities, with products targeting investments that highlight gender diversity, human rights and socially responsible corporate culture or investments that avoid issuers in industries that raise social or policy concerns.
The past few years have brought a massive shift toward ESG investment activity in the wealth management sphere in U.S. and around the globe, where North American institutions have exhibited lower uptake of ESG principles than their European or Asian counterparts. Around 80% of wealth managers now are integrating ESG considerations into their wealth clients’ portfolios, up from 37% three years ago. 50% of wealth managers are incorporating impact investment considerations, up from 18%, and one third are “actively considering” doing so according to wealth manager investment survey done by bfinance 2, investment consultancy firm with a global footprint.
WAM managers should be prepared to explain their investment processes. Few pointers might include the existence of sustainable and agile strategy for managing the company’s ESG activity, customization of the ESG program by asset class, good understanding of the regulatory and tax implications for the assets that are managed. Related to these topics are key considerations of how the asset manager is taking advantage of the company’s ESG-related revenue opportunities or will the asset manager activities pass investor scrutiny for transparency ad investors would like to know how much they can trust ESG claims and avoid any “greenwashing.”
Securities and Exchange Commission (SEC) and Federal Reserve play a crucial role in setting the U.S. ESG agenda by establishing and assessing ESG metrics for the institutions that they oversee. Consistent with increasing investor focus and reliance on climate and ESG-related disclosures and investments, SEC3 stepped in to create a Climate and ESG Task Force in the Division of Enforcement in 2021 with primary focus to proactively identify ESG-related misconduct. It will bring together a broad array of experience and expertise which will allow SEC to better police the market, pursue misconduct and protect investors.
As investors and regulatory bodies become more attuned to ESG, the financial services industry is now seeing an influx of capital allocated to ESG opportunities. ESG is becoming the “industry standard” as consumers gravitate towards brands that address ESG issues in ways that align with their own values.
As ESG investment practices and reporting continue to evolve, firms that innovate more quickly will race ahead. Asset managers need to support financial advisors to meet the responsible investment needs of their clients. For instance, retraining wholesalers and product specialists to clearly articulate a company’s ESG array will also be essential.
Recommendations for financial organizations to advance the ESG agenda and stay ahead of the competition:
- Ensure the firm is prepared to manage all aspects of ESG risk and compliance and maintains a strategic approach to Green, Social and Sustainability;
- Assess the integrity of ESG data being utilized, which are hard to track and still evolving, in your company's data management standards and methods, especially when supplemented by third-party data;
- Align to an ESG ratings provider or an ESG data aggregator organization so that the company’s ESG performance can be measured and tracked relative to other firms;
- Create transparency for improved ESG investment processes and data management; encourage the better use of ESG global data assets for sustainability which in turn will lead to better financial and societal outcomes;
- Develop and implement training programs to inform their stakeholders internally and externally about ESG and how it is going to affect “Business as Usual”; and
- Upgrading advisory toolkits, especially model portfolios which increasingly guide allocation decisions, will facilitate adoption.
1. ESG: Transforming asset management and fund distribution
2. bfinance - Wealth Manager Investment Survey
3. SEC Response on Climate and ESG-related Risks and Opportunities