The unsustainable cost of ESG

The unsustainable cost of ESG

The unsustainable cost of ESG

When everyone is doing something it is tempting to jump straight in and follow the herd, usually without being fully prepared or informed.

Modern vernacular would term it FOMO – fear of missing out – and there’s a lot of that in the fund and wealth management industry at present with a constant stream of ESG investing-related announcements from across the sector.

According to Capgemini’s World Wealth Report 2020, more than a quarter of high net worth individuals (with investible assets of $1m or more) said they were interested in sustainable products. That figure rose to 40% among ultra-high net worth individuals (with $30m or more to invest).

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As wealth transfers from baby boomers to their millennial offspring, it’s likely such numbers will rise even further.

The multi-manager team at BMO Global recently interviewed their underlying active managers and found that over 60% increased their focus on ESG over the past few years with almost 60% having a dedicated ESG team.

This growing supply is responding to rising demand, but in their rush to launch ESG solutions, many players are commonly overlooking the human and capital cost of creating a high quality proposition, potentially increasing the risk of a fiduciary issue in the process. 

Higher hurdles

When ESG investing began emerging on a significant scale, a decade or so ago, investors’ understanding of the concept was limited and that made it easy for several strategies and funds to be marketed as “sustainable” without any real ESG credentials in either their process or objective.

But the maturation of the sector means that just performing a simple screen is no longer justifiable and the risk of “greenwashing” is real and under scrutiny by the regulators, media and investors.

New rules, such as the EU’s Regulation on Disclosures Relating to Sustainable Investments and Sustainability Risks, which come into force in March 2021, will create a huge and costly regulatory burden that many asset managers and wealth managers are probably underestimating. These disclosures will force many financial players to: communicate on how they integrate sustainability risks; calculate specific measures of their adverse sustainability impacts; and explain how they consider and promote environmental or social characteristics within their investment processes.

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UCITs and MiFID firms will be required to develop several ESG investment policies across their entire product range and at the level of the legal entities, they will have to define a precise list of ESG values that must be reflected in their daily operations. They will have to develop an ESG framework that each of their funds can follow as well as regularly reporting on the “ESG performance” of their products.

We think the concept of “ESG performance” is going to be very powerful going forward. It won’t be enough to be labelled ESG but products will have to be measured and compared on their overall “ESG performance” and institutional and private investors will be able to discriminate on this basis.

Firms must put serious time and money into ensuring they are competitive and comply with a host of other regulatory demands to provide full transparency for their ESG and sustainable labelled investments. This will require subscribing to multiple ESG data providers to enable robust investment and valuation processes, monitoring all potential ESG risks and the potential effects on individual funds, and, crucially, be able to measure and communicate this clearly at portfolio level to the end-investor on a regular basis.

This means firms seeking to enter the ESG space will not be able to cut corners, and anything short of a comprehensive approach will leave a firm lacking the ability and/or credibility to meet their aims.

While larger players with significant scale and resources are likely to be able to absorb the costs of launching such an undertaking, a significant amount of firms will have no choice but to work with ESG specialists  that can help them meet regulators’ demands in a cost-effective way.

Cost pressure

Committing to a costly investment at a time when margins are already under pressure from passive rivals, existing regulatory burdens and the strain of providing seamless customer interactions via the latest technology will test the mettle of many senior leaders within investment firms.

While there are undoubtedly rewards – total assets in ESG investments have now reached roughly well over $30tn globally – investors’ requirements of firms that claim to be able to satisfy their ESG needs are significant and will only increase in the months and years to come.

This is particularly the case for high net worth investors, whose appetite for ESG investing is growing rapidly and which could be an attractive client base to target for firms that engage the right support to implement their proposition properly.

More than a trend

Beyond just being a growing trend, there’s increasing evidence that ESG investing is here to stay.

This resilience, coupled with the rising tide of investor cash towards ESG mandates, means fund managers and wealth managers without such a capability will likely be experiencing extreme FOMO right now.

But it is important they don’t just jump in without thinking – taking time to craft a high-quality proposition is better than being in the game but underprepared.

Simone Gallo is managing director at MainStreet Partners

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