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Today New City Initiative is comprised of 43 leading independent asset management firms from the UK and the Continent, managing approximately £500 billion and employing several thousand people.

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The Move to Sustainability

Published by Charles Gubert

If an asset manager – five years ago – slightly exaggerated or over-inflated their adherence to ESG (environment, social, governance) values, they would likely have fielded some mild criticism for nothing other than operating a cynical marketing tactic or PR campaign in order to win mandates. Times have, however, changed. Nowadays, such behaviour – also called greenwashing – could in extremis prompt existing clients to issue redemption requests or result in a blacklisting among prospective investors as institutional and retail allocators increasingly embrace the ESG model. 

Regulatory concern about the extent of greenwashing – along with a broader commitment to meet various policy objectives set out in international agreements such as Paris COP21 and the UN’s Sustainable Development Goals (SDGs) – have prompted the European Commission (EC) to act decisively. Among the EC’s proposals – announced in March 2018 – were recommendations that asset managers and asset owners integrate sustainability risk into investment decisions and report on their activities to end clients. In order to enable investors to assess the sustainability of managers across the board, the EC also advocated the establishment of an ESG taxonomy or basic standard.

While an increasing number of NCI members – according to a soon to be published survey – integrate ESG into their investment processes as a means to better manage long-term risks, drive performance or widen their investor appeal, there was scepticism among our constituents about the need for regulatory intervention particularly as the ESG market has been developing organically. With more investors asking for exposure to ESG linked assets, it was natural that managers would provide products to satisfy their demands. While the EC’s initial proposals were open to interpretation, ESMA has struck a more moderate tone, clarifying many of the issues which NCI had. 

One of NCI’s concerns with the initial proposals was that managers might be forced to divest from certain sectors or companies which did not meet the EC’s sustainability criteria. As long-term investors, asset managers play a large role in changing corporate behaviour and ensuring businesses are sustainable. Forced divestments would constrain the ability of managers to drive reforms at corporates, thereby resulting in the continuation of unsustainable practices. In its consultation, ESMA assuaged those fears, stating integration of sustainability risks into the investment approaches at AIFMs and UCITS should be done on a high-level principles-based-approach.

Rather than demanding managers explicitly apply ESG into their investment strategies, ESMA is proposing firms incorporate sustainability risks into their due diligence and risk analysis just as they would assess an underlying securities’ credit risk or interest rate risk. “To this end, sustainability risks need to be captured by the due diligence process and risk management systems in a way and to the extent that is appropriate to the size, nature, scope and complexity of their activities and the relevant investment strategies pursued,” reads the consultation.

A number of managers will already have such mechanisms in place although ESMA has conceded that some changes (i.e. increased allocation of resources to monitoring sustainability risks and structural changes to oversee those sustainability risks) may be required at some firms. This will come at a cost to asset managers who have yet to factor sustainability into their businesses, although given the evolving investor environment, it is arguable that such changes would have happened irrespective of EU intervention. It is possible that those forward-thinking managers which implement policies on sustainability risk could find themselves in a strong capital raising position.

NCI will be releasing a paper, based on a series of interviews and a survey of its membership, in the coming weeks looking at how boutique asset managers apply ESG into their investment strategies, along with analysis of the proposed EC regulations on sustainability.