Asset managers are paying more attention to ESG — environmental, social and governance — concerns, according to a recent report from Northern Trust.
“While many European markets have long made ESG a focus in their investment strategies, other mature markets in parts of North America and Asia have had a less straightforward approach,” Northern Trust reported, although recently Canadian asset managers have moved ahead of the U.S.
“Alongside the pandemic, the summer of 2020 brought a global reckoning with racism, originating in the U.S. with multiple protests and marches. The tumult brought on by the combination of these two events led many investors who had previously not emphasized ESG factors to take a closer look at the positive impact on the world that environmental, social and corporate governance perspectives could bring,” the bank said. “The industry consensus is that the emerging social responsibility emphasis will stick.”
“We are seeing an uptick in adoption of ESG strategies across public pension funds, endowments and foundations, here in the U.S. and globally,” said Peter Lantero, Head of U.S. Institutional Investors Group, Northern Trust Asset Services. “U.S. corporate retirement plans have been slower to adopt as the ERISA guidance on ESG is not straightforward and will require additional clarification. Regional agendas will also be a factor in ESG adoption: for instance, Texas recently passed legislation to penalize businesses that cut ties with the oil and gas industry, while Illinois has a law on the books requiring public pension funds to consider ESG issues in the investment process. To gain adoption similar to what is happening in EMEA and Canada, the U.S. would need a more consistent oversight regime at the federal level to reduce the uncertainty and risk that directors may perceive about pursuing ESG strategies.”
Whether firms will actually practice ESG or merely claim to follow ESG guidelines is another issue.
“One of the big differentiators now is that demand is growing from the participants in the plans – who then push the asset owners to expand the investment panel to include ESG options,” Lantero added. “In response, asset managers are offering new strategies for ESG, sustainable or values-based investing. This has the feel of a long-term trend, but legislation or regulatory change might continue to lag the market, especially as federal and state governments take widely varying approaches to ESG.”
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“Another factor in the growth or staying power of the ESG trend is emerging technologies like machine learning, which could make a huge difference in helping asset managers and institutional investors manage the complex data challenges associated with values-based investing.”
The Wall Street Journal (WSJ) reported that DWS, an asset manager largely owned by Deutsche Bank, is under investigation by the SEC and federal prosecutors for inflating its ESG claims. The asset manager fired its sustainability chief, Desiree Fixler, a day before releasing its annual report which claimed great ESG progress during 2020.
She had made a presentation to the board saying the firm had “no clear ambition or strategy, lacked policies on coal and other topics…”
The WSJ concluded that “The probes indicate regulators’ interest in money managers’ efforts to offer products related to climate change, social issues and corporate governance risks. The SEC earlier this year established an enforcement task force to look for misleading ESG claims by investment advisers and public companies.”
Lantero said that while he can’t comment on a specific case, “one of the benefits of enhanced oversight should be greater confidence in the validity of ESG strategies. Global custodians and fund administrators can provide tools to monitor investments on a post-trade basis, to make sure third-party investment managers are following the guidelines of an ESG mandate.”
ESG is a hot part of the marketing by asset managers. Citing Morningstar, the Journal said “assets in ESG funds surpassed $2 trillion globally in the second quarter, almost tripling in three years.”
Europe has adopted regulations for ESG including the Sustainable Finance Disclosure Regulation (SFDR), and the Pensions Directive. Northern Trust said Europe is the global leader in ESG regulations such as “the EU Taxonomy Regulations, aimed at asset managers; the Non-Financial Reporting Directive, aimed at corporations; the Sustainable Finance Disclosure Regulation, seeking to combat greenwashing of financial products; and the Pensions Directive or IORP II, aimed at regulating financial institutions’ management of collective retirement schemes.”
Northern Trust was impressed: “The EU’s approach to ESG regulation serves as a well-designed plan for other regions to emulate when developing their own regulatory frameworks.”
The EU has developed a “framework [that] applies to all financial products which set an environmental sustainability objective or promote environmental characteristics. Financial products that do not take environmental sustainability into consideration must make a statement acknowledging this.”
Another regulation applies to companies with more than 500 employees. They have to “report on practices including environmental matters, social matters and treatment of employees, respect for human rights, anti corruption and bribery, and diversity on company boards so that investors, consumers, policy makers and other stakeholders can gauge an organization’s non-financial ESG performance.”
Northern Trust said the EU regulations seek to prevent “greenwashing” — marketing and public relations claims that are not supported by actual practices.
Canada is moving ahead of the U.S., Northern Trust says with ESG ETFs growing 67% in 2020.
“Then, in November 2020, several major Canadian asset owners made a high-profile stand for ESG standardization to be passed into law. The CEOs of Canada’s eight leading pension plan managers with combined assets of approximately CAD$1.6 trillion signed a statement pushing for a more complete and consistent disclosure on ESG practices from investors and corporations.” In the U.S., ESG assets make up 33% of all U.S. assets under management, the Northern Trust report said.
The bank expects that the SEC will accelerate its ESG emphasis under the leadership of Gary Gensler. President Joseph Biden has signed an order charging the Financial Stability Oversight Council to assess climate-related financial risks and report on how its member agencies, such as the SEC and CFPB integrate climate financial risk into their practices.
Lantero said technology is helping.
“Increasingly we also see demand in the front office – particularly from institutional asset owners such as large public pension plans that manage assets in-house – for pre-trade solutions to guide investment decisions. Through our partnership with a fintech, Equity Data Science (EDS), we can help digitize the internal ESG rating process, which is often stuck in large cumbersome spreadsheets that are inherently inefficient for investment teams to collaborate. Our clients can include ESG as an input factor in the decision process and simulate portfolio impact across various metrics. They can perform ESG materiality assessments over time by decomposing the relevant pillars specific to each investment’s industry.