The bar is getting higher for ESG considerations

Now, the list of responsibilities that asset owners, their trustees and managers must consider in making and maintaining their investments has grown to include the financial impact on their investments of carbon emissions and climate change risk; gender, ethnic and sexual diversity; modern slavery; water consumption – and the list goes on. 

Under the heading of corporate structure alone, MSCI’s environmental, social and governance ratings look at 96 governance metrics. Regulatory interventions aside, encouragement is increasingly coming from the demand side as well. 

As millennials consider the impact of their lifestyles on the planet, there is evidence that they are taking a deeper interest in the impact of their investments

James Knowles, Novarca UK

As millennials consider the impact of their lifestyles on the planet, there is evidence that they are taking a deeper interest in the impact of their investments, either directly in savings or indirectly through the institutions they support, such as their universities. 

Asset owners struggle to keep up

In the US, 29 universities have completely eliminated fossil fuel investments from their endowments, and many more selectively exclude companies that are deemed non-sustainable. In total, assets invested with an ESG mandate are growing rapidly and are estimated to exceed $20tn (£15tn) in 2020. 

With the best will in the world, traditional asset owners and their trustees are struggling to keep up with their growing fiduciary responsibilities, even though some have successfully held their managers’ feet to the fire with quarterly meetings, AGM attendance and a thorough digestion of all the manager’s publications. 

Last October, the Pensions Regulator imposed new legal reporting duties, which require, for example, a clear demonstration that investment decisions consider the financial impact of climate change risk, along with all other financially material ESG considerations. And the bar is only getting higher.

TPR has announced its intention to ratchet up legal duties again this year, and will extend many of the same responsibilities set out in its DC Investment Guidance to DB. 

At the voluntary level, signatories of the revised stewardship code are now required to provide not only a clear statement of investment principles, but a demonstration of the fiduciary’s pursuit of those principles through detailed actions and outcomes.

These responsibilities are not only in the familiar ground of public assets, but the code now explicitly covers private assets, where transparency can be more difficult to generate. 

Technological solutions come to the fore

Thankfully, the market has responded with myriad solutions to address these growing requirements. Not surprisingly, technology is at the heart of many of these solutions, taking the burden of monitoring and initial analysis away from trustees and their managers, while flagging issues for their deeper consideration. 

Tools now exist that proactively communicate with managers on behalf of asset owners, requiring them to attest to their compliance with agreed ESG standards. The systems then keep legal records of manager declarations and flag areas of non-compliance or concern, issuing reports for managers and trustees. As an asset owner’s views on ESG best practice develop, so can the software. 

Of course, the use of these tools in no way relieves the fiduciary of their responsibility, but they can help them discharge it. The myriad data points required by TPR can be automatically requested, consolidated and distilled to cover regulatory requirements, leaving fiduciaries with more time to investigate highlighted anomalies and dedicate more time to looking after members. 

The importance of data for trustees

As the debate intensifies over a fiduciary’s duty to generate positive investment performance versus a strict adherence to their ESG principles, asset owners may also want to collect the data showing the opportunity cost of divestment from sectors such as fossil fuels.

The local authority funds of Greater Manchester and West Yorkshire have recently presented data showing that had they divested from the likes of BP and Centrica in favour of the remaining UK index, it would have cost them a combined £600m in positive contributions to their beneficiaries’ assets. 

So as the growth of a fiduciary’s legal ESG duties continues its inevitable acceleration, the best defence a trustee or their manager can adopt is to be well informed of all the facets of their decision-making processes.

The raw collection and analysis of data is increasingly being delegated to purpose-built systems, leaving fiduciaries with the necessary data to make appropriate decisions combining their ESG duties with their core responsibility to produce the optimal outcome for their beneficiaries.

James Knowles is managing partner at Novarca UK