Are you ready for ESG regulation?

These days, your clients often want more from their investments than just strong financial returns. Many now want reassurance that their capital is also being put to work for the greater good. As a result, demand for incorporating Environmental, Social and Governance (ESG) criteria into mainstream investing has increased dramatically. As an ever-increasing number of responsible investment solutions enter the market, regulators are working to adapt to this shift.

Closer to compulsory

A whole raft of EU regulatory initiatives are coming down the line for responsible and sustainable investing. Chief among them, as far as the UK wealth management industry is concerned, is the EU’s Sustainable Finance Disclosure Regulation (SFDR) and amendments to the MiFID II regulatory framework, meaning that advisers must ask clients about their responsible/sustainable preferences as part of the suitability process. Under SFDR, advisers would be required to set out the extent to which consideration of ESG criteria forms part of their advice. This means that even firms with no plans to offer sustainable investment solutions would need a policy in place.

The legislation was due to come into effect in March 2021, however this was on the assumption that the UK’s financial regulation remained aligned with that of the EU post-Brexit. With Brexit negotiations running to the eleventh hour, the proposal could not be legislated by the UK Parliament in time to come into effect in March as planned. Despite the delay, the direction of travel is clear and it’s likely these legislative changes will eventually apply to the UK in some form, or that the UK regulator will create its own rules for advisers.

As these new rules will likely result in all clients being asked to consider ESG criteria, it’s reasonable to assume that a greater number of your clients will have questions about this, and, that it could result in greater inflows into sustainable funds and services.

ESG investor spectrum

As with all other areas of financial planning, your clients will have different levels of interest in, and understanding of, sustainable investing:

"My investments can do that"

Some clients may not realise that they care about investing sustainably, or that the option exists, until they are asked about it.

Adviser action: add value by informing your clients that they can invest while benefitting their values more than they even realised was possible.

“I only care about financial returns”

Some clients will know very little, or default to the position that any ethical or ESG solution limits the universe of investment opportunities. They may have previously avoided these investments in the belief that this will negatively affect returns.

Adviser action: your client may want to know more about the topic and / or could benefit from further support and education.

“What are my sustainable investing options?”

Some clients will be well versed in ESG criteria and already appreciate that their investible wealth can be put to work to generate more than just financial returns. Such clients are aware that their money can help create a better and more sustainable future, whilst presenting a chance to tap into some of the latest and most promising investment opportunities.

Adviser action: ensure you have a range of high quality sustainable investment solutions available for your clients.

Regardless of client type, it’s important that you can speak with confidence when it comes to sustainable investing. You will need to be able to clearly articulate how sustainable investing can affect investment performance, and be comfortable in the knowledge that you have the appropriate solutions to recommend to your clients.

Why outsource investment management?

For some time, many financial advisers have chosen to outsource the management of their clients’ portfolios to those that specialise in investments. The benefits of doing so are well-known, including a clear division of labour; you can focus on financial planning and advice, while investment managers provide dedicated and specialist expertise. As well as a better and more efficient all round service, the overall cost to the client can also be lowered. There is now an additional reason to consider outsourcing the investment management function: ESG criteria and regulation.

Given the likely regulatory changes and increasing client interest, you may find yourself having to quickly adapt and evolve your working practices. You will need to consider whether you can ultimately be a financial planner, tax expert, investment manager, and now an ESG specialist, and perform all these of functions to your high standards. If you haven’t already outsourced investment management, you might now have another reason to do so. A carefully chosen investment provider should not only be able to take care of day-to-day investment management, but significantly lighten the ESG burden too.

Choosing the right investment provider

You will need to be sure that any investment provider you choose to work with are fully transparent on all ESG criteria. Those that have a clearly defined responsible investment policy, and are able to plainly illustrate and explain the adaptations made to their investment process when running sustainable investment solutions, are likely to be a good starting point in your selection process.

An investment provider that is on top of their ESG requirements can:

1. Distill the many forms that sustainable investing can take
2. Clearly define the varied (and often conflated) terminology used
3. Provide a clear outline of how they integrate ESG factors into their investment process

Investment managers that also provide training on the subject can help you develop a better understanding of the issues at hand and the terminology used, often interchangeably, throughout the industry. For example, one challenge with the definitions of ESG is that some funds and asset managers tend to focus on the “E”, or green, part of ESG more so than the “S” and the “G”. At Close Brothers Asset Management, we feel that simply applying screenings and exclusions around environmental issues is not a high enough threshold for proper ESG integration. The “S” and “G” are just as important.

Responsible investing at Close Brothers Asset Management

Our responsible investment philosophy is rooted in our objective to help your clients meet their financial goals by being an active and effective steward of their capital. We define responsible investment to be an investment approach which recognises the potential impact on an investment’s value from interaction with its stakeholders, including; employees, customers, suppliers, and the environments in which it operates, as well as investors.

Investment risks and opportunities inevitably include ESG-related issues, so we feel it is important to incorporate an assessment of ESG factors within our research process. We then reinforce this through active engagement (such as proxy voting) for our direct equity investments.

While an assessment of ESG factors is incorporated into the research process for all of our investment offerings, we also offer fully sustainable solutions for those that wish to further align their investments to ethical values and impact themes:

Outsourcing investment responsibilities could ultimately save you time, reduce costs and help mitigate investment and regulatory risk. It could also help future-proof advice businesses, ensuring that they are better placed to maximise on opportunities presented by the ever-evolving ESG landscape.

Terminology breakdown

• ESG stands for Environmental, Social, and Governance. These are categories of typically non-financial factors that can be material to a company’s business. ESG goes beyond what a company does, and looks at how it conducts itself, and whether it is doing so responsibly. As part of our financial analysis, we analyse ESG factors to identify and assess material risks and opportunities for a company.
• Responsible Investment (RI) is the practice of incorporating environmental, social and governance factors in investment decisions and active ownership.
• SRI stands for Socially Responsible Investing. This is a broad term for investment disciplines which seek to consider both financial returns as well as social and environmental good to bring about positive change to society. These strategies often go a step further than RI, to have specific ethical, ESG, and impact criteria, and may employ screening.
• Sustainable investing is an investment discipline which involves actively seeking investments in companies contributing positively to the world, and incorporating ESG factors into investment decisions to better manage risk and enhance long-term financial returns