ESG investing

Once upon a time, there were a few funds categorised under the general heading of ‘Ethical Investments’, These funds were pretty much just normal funds that happened to exclude, or aimed to exclude, investments in a few market sectors that some clients considered beyond the pale – primarily tobacco or armaments. 

The range of such funds has grown markedly in recent years, reflecting the significantly increased interest in all things related to climate change.

The funds themselves have become more sophisticated. Rather than simply claiming to avoid tobacco or armaments or other ‘undesirables’, funds these days have outgrown the simple ‘ethical’ label and are now categorised as ESG. 

Environmental, social and governance (ESG) criteria are a set of standards for a company’s operations that socially conscious investors can use to screen potential investments and ensure they invest only in a manner that is consistent with their views on ecological matters.

Environmental criteria consider how a company performs as a steward of nature.

Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities in which it operates.

Governance deals with a company’s leadership, and its policies on things like executive pay, shareholder rights or internal and external controls/audits.

The FCA takes notice
Taking a broad view of its remit, and mindful, despite BREXIT, of proposals from the EU, the FCA is trying to do its bit to contribute to action in respect of climate change. This is not entirely unreasonable since, in the event that climate change did result in significant environmental problems globally, investors would likely have more to worry about than how to invest for best returns.

Investment Governance Committees (IGCs)
In December 2019, following the publication of a previous discussion paper and feedback paper, the FCA issued a policy statement including some final rules (COBS 19.5) affecting Investment Governance Committees.

The rules extend the remit of IGCs, with:

  • a new duty for IGCs to consider and report on their firm’s policies on environmental, social and governance (ESG) issues, member concerns, and stewardship, for the products that IGCs oversee;
  • a new duty for IGCs to oversee the value for money of investment pathway solutions for pension drawdown (pathway solutions).

We have been asked by some adviser firms how this affects them. The simple answer is that it doesn’t, at least not directly.

While many firms have an Investment Committee, an IGC is defined entity that does not apply to adviser firms. It refers to providers and other firms that manage a pension scheme – including SIPP operators, who fall within the definition.

The actual definition in COBS is:

“This section applies to a firm which operates a relevant scheme in which there are at least two relevant policyholders.”

What about general investment advice?
Serious discussions around the part that can be played by financial firms more generally in the climate change arena have been taking place for at least three years now. There has been a major European Commission initiative on financing sustainable growth running since 2018.The European Securities and Markets Authority (ESMA) made its views known to the various EU regulators in 2018 and the IGC rule changes described above are one result.

Meantime, some adviser firms have been passingly aware of all this and we have had questions such as …

“On what date under MiFID rules do financial advisers have to start asking clients if they want their money to be invested ethically?”

This is essentially still under consideration. In January 2018, the Commission published two draft delegated regulations on integrating ESG considerations into investment advice. ESMA has been considering how these can best be implemented and published final guidance in April 2019.

The FCA stated that they were working according to the required Action Plan timescales which meant that the first three legislative proposals were due by the end of 2019. These first proposals do not explicitly cover the adviser aspect. So the planned timescale for implementing the sustainable growth rules is currently far from concluded and depends upon a number of legislative stages being in place before the next can be safely implemented. On 20 September 2019, a group of major European financial institutions* wrote to the European Commission warning of the difficulties they foresee in meeting the suggested timeline for implementation.

(*The Association for Financial Markets in Europe (AFME), the Alternative Investment Management Association (AIMA), the Association of Mutual Insurers and Insurance Cooperatives in Europe (AMICE), the European Association of Cooperative Banks (EACB), the European Banking Federation (EBF), the European Fund and Asset Management Association (EFAMA), Insurance Europe and Pensions.)

So the straight answer to the ‘when?’question is that we don’t yet know the date by which advisers will be required to ask clients if they want their money to be invested ethically. In fact, it is not even clear if that will be the requirement. The relevant delegated regulation is Article 21(1):

“Where ESG considerations are relevant for the provision of investment services to clients, firms should take them into account when complying with the above requirements.”

That is open to a fair bit of interpretation until such time as the FCA actually publishes finalised rules and guidance. Meantime, we note that the delegated regulation will require ESG considerations to be taken into account but does not actually require firms to offer such solutions.

However, while this aspect might well become an explicit requirement at some point, it effectively already is a requirement. COBS 9 requires firms to take ‘reasonable steps’ to ensure that any personal recommendation is suitable for the client and to obtain the necessary information regarding the client’s financial situation and investment objectives. In our view, a client’s views on, or desire for, ethical investment would be a relevant element of ‘necessary information’.



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

It is relevant for adviser firms to be aware of the new rules relating to IGCs as it relates to pension schemes with which they might be involved.

And we think that firms need to be aware of the increased regulatory focus on the broader climate change impact of financial services and also consider the potentially greater demand from clients for ESG investments. Firms should ensure that their investment process considers where ESG solutions fit with clients and have robust research and due diligence processes to assess individual funds against required ESG criteria.

Regardless of any forthcoming rules and guidance, current suitability rules already require a client’s ethical objectives to be taken into account. This means that firms’ fact finding and advice process needs to identify whether this is a concern for a particular client and advise accordingly.

Things to consider
There are many side issues around ESG investment that mean it is not as simple as asking a client if (s)he wants to invest ethically. 

– Social investing is still relatively early stage, and niche. The available investment choice is therefore limited by comparison to the overall market, which can make the creation of diversified asset allocation more difficult to achieve;
– There are ongoing debates about ESG criteria in terms of clarity and consistency, and the FCA has warned fund managers that they will be monitoring for ‘greenwashing’ – a fund presenting itself to be more ESG than it actually is;
– There are questions around consumer protection – for example how do you measure detriment around ESG issues if a complaint goes to the FOS?

Action Required By You

For information.

Contact ATEB if you would like to discuss how to incorporate ESG considerations in your advice process.

SUIT - Beautiful Reports
SUIT - Complete Control
SUIT - Comp confidence
previous arrow
next arrow

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.

Contact Us

Brought to you by

Explore more articles in this category

Other articles that you might be interested in