ESG, ESG, ESG!

Well, 21 March has come and gone and, while it is presumed that the EU’s new disclosure rules around sustainable investments might have gone live on that date as scheduled, nothing much happened in the UK that day. At least not much related to ESG, if you ignore the apparently ever-increasing number of articles on the topic. The reason for the 21st being a business as usual day in the UK was because the FCA announced some time back that they would not be adopting the EU rules known as The Sustainable Finance Disclosure Regulation (SFDR). Instead, the UK has signed up to the Taskforce on Climate related Financial Disclosure (TCFD).

The TCFD was established by the Financial Stability Board in 2015 and published its final report in June 2017. The report set out 11 recommended disclosures under 4 pillars to promote better disclosure. These are governance, strategy, risk management and, finally, metrics and targets. Since then, the TCFD’s recommendations have attracted widespread support internationally, with more than 1,500 companies having now publicly expressed their support.

The UK government was one of the first publicly to endorse the TCFD’s recommendations and made their implementation a central part of its 2019 Green Finance Strategy. In November 2020, a cross-Whitehall/cross-regulator taskforce (including the FCA) published a Roadmap charting a path towards mandatory TCFD aligned disclosure obligations across the UK economy over the next 5 years, with most of the measures to be introduced by 2023.

New listing rules have already come into effect as from 1 January 2021 which apply to commercial companies with a UK Premium listing. In-scope issuers are required to state in their annual financial report whether they have made disclosures consistent with the recommendations of the TCFD or explain if they have not done so.

What does this mean for adviser firms? 

It was fairly widely believed that advisers would have to follow new ESG related rules from 21 March. The rule as described in the delegated regulation was:

“Investment firms shall take into account sustainability risks when complying with the requirements set out in this paragraph. When complying with the requirements set out in this paragraph, investment firms shall take into account the nature, scale and complexity of the business of the firm, and the nature and range of investment services and activities undertaken in the course of that business.”

So, the requirement was in reality a bit vague – what does ‘take account of’ mean? In any event, that requirement is not applicable for UK adviser firms (unless doing business in the EU). The FCA may well introduce some specific rules in a similar vein in due course but, at time of writing, it is business as usual – nothing has changed for advisers.

Except that there has been change. First, partly in reaction to a growing focus on sustainability and green causes and partly in expectation the EU rules coming along, the past year or two has seen a significant increase in the number of ESG type funds (or at least funds claiming green credentials – greenwashing is a topic for another day).

This has coincided with an increased awareness and interest in the adviser community – for much the same reasons.

And there are reports of an increased interest in sustainable investing from clients. A recent Boring Money survey of investors aged 40-65 with assets from £50k to £750k , commissioned by Quilter, found that 43% of investors thought considering responsible investment was ‘very important’. Further, 25% stated that they would definitely accept lower returns or higher risks if those were the trade offs involved with sustainable investment. Cynics might suggest that there are lies, damned lies and surveys and it is true that serious studies show that people often say one thing but do another. For example UK election polls regularly show that people say they would gladly pay extra tax to fund the NHS or similar but then vote for the party proposing the least taxation. However, numbers don’t lie, do they? So, the fact that, according to the Investment Association, the inflow of investment to ESG type funds quadrupled in the first three quarters of 2020 to £7.1bn gives a good deal of credence to the largely anecdotal ‘evidence’ arising out of surveys like the one mentioned above.

You can be green, or you can make money

The conventional wisdom that there is the trade off between green and good returns referred to in the Quilter survey is very much open to challenge now.

Fidelity’s Putting Sustainability to the Test report, published in November 2020, showed stocks at the top of the fund house’s ESG rating scale outperformed those with weaker ratings in every month from January to September, apart from April.

The Fidelity report came on the heels of Morningstar research published in June 2020. The firm analysed the performance of 4,900 funds to find out whether sustainable funds can beat their traditional counterparts over the long-term. Almost six out of 10 sustainable funds delivered higher returns than equivalent conventional funds over the past decade. The majority of strategies have done better than non-ESG funds over one, three, five and 10 years.

There is definitely a message of sorts here, but a little caution is prudent. Numbers may not lie but they sometimes mislead. Readers will be familiar with the phrase ‘past performance is not a reliable guide to future returns’. Markets are cyclical and sometimes subject to major events such as wars or pandemics so care has to be taken not to rely too heavily on data over a relatively short period such as ten years. The long running active / passive debate was for many years testament to that with a variety of data being used to ‘prove’ both sides of the argument. And the investing world has seen significant changes over the past few decades. There was a time when almost everyone was willing markets to rise because that was how gains were made. The exceptions to this were brokers who didn’t mind much if the markets rose or fell provided that trades were made earning them a healthy commission. Nowadays, there is a substantial ‘team’ of players who are betting on this or that market or asset failing because they have laid bets that will pay off if that happens – hedge funds etc. Then there is the now ubiquitous computerised trading where stocks are bought and sold in nanoseconds, way before any human would spot the opportunity. All of which is why the ‘past performance’ caveat is so undeniably true … compared with even a few years ago, the world is a different place.

Despite those words of caution, there is clearly a move towards sustainable investing and a growing belief that there is a good reason why ESG type companies have performed well, namely that a company’s focus on sustainability is fundamentally indicative of its board and management quality.

We’re all going green or a reaction to the pandemic? Who knows? All that matters is that advisers recognise the changing attitudes and react appropriately.

Action required

Advisers have escaped the mandatory requirement to ‘take account of’ the ESG preferences of clients that would have come with the EU rules had the UK remained a member. But that should not and does not negate the need to recognise that the job of the planner has always been to ‘take account of’ all relevant information when advising a client. Client preferences in relation to sustainable investments should be identified and addressed. This has always been a suitability requirement since regulation began all those years ago.

That there is now an added commercial benefit for advisers arising from the increasingly strong demand for sustainable investments, and the indication that such investments might be where some of the best future returns will be found, is just grist to the sustainably powered windmill that is the argument for ESG to play a formal part in advice to clients.

Important Note: ATEB news is intended to provide general information ONLY. The content, including any views expressed or guidance provided, does not replace the need to comply fully with FCA Rules and Guidance. Unless you have discussed news article content with ATEB, and specifically how it relates to your circumstances, then ATEB disclaims all liability and responsibility and actions arising from any reliance placed upon it. For the avoidance of doubt therefore, any reliance you place on such information without our consultation is at your own risk.

ATEB Compliance offers compliance and regulatory advice.

ATEB Suitability provides report writing software for the financial services market.

Our View

The world changes and smart businesses change with it. Adviser firms need to recognise the apparently unstoppable increase in state and individual interest in all things green. The ESG market is still relatively immature but growing up fast. So, while it is undoubtedly true that the data and research tools are not yet as well honed as those firms have used in recent years to support their investment and advice processes, sustainable investment cannot be ignored and should be factored into advice as appropriate to the client’s preferences.

Action Required By You

The first step in addressing the ESG trend is to understand it. Firms may need to implement learning programmes for advisers alongside implementing appropriate changes to fact finding, advice and investment research processes. ATEB can assist firms in creating robust processes that meet the needs of the business and its clients.
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About the Author

Technical Manager - Often referred to as the Oracle or the Sage, Alistair has a wealth of financial services experience. He is our go-to Technical Manager and enjoys nothing more than a complicated conundrum. Feel free to test his renowned knowledge by getting in touch.

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