ESG has come of age. The funds industry is preparing to respond to the changes and Jersey is ready to play its part in supporting the needs of managers and investors alike. I recently discussed this with Jersey professional, Monique O’Keefe, who is a non-executive director of LSE listed real estate company, Phoenix Spree Deutschland and is Chair of its Corporate Social Responsibility (CSR) Committee.
Monique said: “The board recognises the importance of long-term sustainable growth – that means ensuring that the Company’s activities contribute positively to society, especially within the communities it operates and also in terms of its environmental impact.”
However, creating the right platform takes time involving multiple counterparties. She said: “It has taken us over three years to develop and implement our policies. I would describe it as a cultural journey for the business where the people who implement the policies are educated along the way.
“ESG principles have become embedded into the business and it has changed the way we communicate, especially to our investors.”
It was not so long ago that investors may have once been reluctant participants. After all, a company director’s fiduciary duty was to maximise shareholder value with less regard to environmental or social considerations or more general governance issues. Yet this is not the case today. The rise of ESG has shifted things and it is now seen as an important component of fiduciary duty.
In 2013-14 studies were published reflecting how good sustainability performance associates with good financial performance. Evidence is now to hand showing the importance of sharing ESG data in assessing risks, strategies and operational performance. More investors are now integrating corporate ESG risks in their decision-making with the aim of increasing returns, particularly pension funds which are being reported as targeting managers with ESG capability.
The shift is the correlation between ESG factors and financial performance, especially as they relate to climate change. Climate change is no longer a distant threat. It is already having far reaching economic consequences and will continue to do so over the long-term. Monique explained: “The key is to be proportionate and demonstrate to investors the value it brings. Value can be about profit but also other non-financial metrics, such as energy conservation, job creation and enhanced reputation. I’ve yet to see a shareholder or investor complain about a proportionate approach to ESG.”
ESG covers a wide sphere of subjects and factors that historically have not formed part of investment analysis. It may include:
- Response to climate change
- How workers are treated
- Supply chain management
- Corporate culture that is positive, builds trust and builds innovation
Managers are now expected to track and report their ESG data. This is now likely to form part of investors’ due diligence to understand the strategy and management philosophy. Monique said: “The key is to actively manage this through competent governance and a board committed to ongoing reporting.
“In the case of Jersey, we are well placed to offer international investors with highly flexible structures which are managed by professionals with credible and long-standing experience of corporate governance and transparency. For many funds in Jersey, there are no direct employees or offices, so it becomes important to be able track and report on the activities of key service providers.”
This is also just as important for private funds as it is for listed companies. Many closed-ended private funds will be expected to report on their particular ESG factors, even though the fund may be closing soon, as the platform will inform investors as to the next fund launch. The manager’s credentials and reputation will develop from this.
In Jersey, the Jersey Financial Services Commission (JFSC) has taken the lead with their Consultation on Proposals to Enhance Disclosure and Governance Requirements for Sustainable Investments. This is aimed at funds that specifically market or hold out to have environmental, sustainable, or socially responsible investments. The consultation closed on 30th September 2020 and feedback is expected during Q4 2020.
Over the last 15 years ESG investing has grown in recognition and is now estimated at over $20 trillion of assets under management or a quarter of all professionally managed assets globally.
It has been built on the principles of the Socially Responsible Investment (SRI) movement with a focus on ethical and moral considerations. SRI tended to focus on the negative (e.g. having a policy not to invest in certain assets), whereas ESG has developed a more progressive approach.
The Global Insights on ESG in Alternative Investing survey of 97 institutional investors in 22 countries conducted by LGT Capital Partners and Mercer found that respondents believed ESG improves risk adjusted returns and formed an important part of risk and reputation management. JP Morgan has reported that ESG factors influence consumer and investor behaviour and corporate returns are higher.
The Financial Reporting Council’s UK Corporate Governance Code has a focus on board responsibility for risk management and the Stewardship Code now further develops this to cover long-term value creation that lead to sustainable benefits for the economy, the environment and society.
For listed real estate companies, the European Public Real Estate Association (EPRA) offers their Sustainability Best Practices Recommendations Guidelines. Monique said: “EPRA Guidelines are based on the latest GRI Standard, and offer a consistent way of measuring sustainability performance to enhance transparency and comparability.”
Real asset investing can have a significant impact on the environment and it is not surprising that the industry is driving standardised benchmarks. For example, it was some 11 years ago that the Global Real Estate Sustainability Benchmark (GRESB) was established by a group of large pension funds who wanted to have access to comparable and reliable data on the ESG performance of their investments. They have now grown to become a leading ESG benchmark for real estate and infrastructure investments across the world.
Investors use GRESB data and analytical tools to manage ESG risks, capitalise on opportunities and engage with investment managers. GRESB validates, scores and benchmarks ESG performance data provided by individual managers on the ESG performance of their assets and portfolios.
For equity investing generally, the PRI’s A Practical Guide to ESG Integration for Equity Investing guides managers and investors on the implementation of ESG integration into their investment decisions and processes. PRI explain that integrating ESG factors into analysis of listed equity investments is the most widespread responsible investment practice in the market today. Several drivers, including increased capital flows into funds with integrated ESG factors are encouraging more and more investors to practice ESG integration.
Different organisations may employ different strategic approaches. These could follow one or more of the following:
- Best in class – investments are held in assets that are ESG leaders.
- Thematic – a top down investment approach where investments are held in themes or assets specifically related to sustainability.
- Impact – where the goal pursued is to achieve a specific positive social or environmental benefit while delivering a financial return.
Whichever is followed, the industry is responding to the need for standardised reporting with the leadership and assistance of the World Economic Forum. Published in January 2020 was the Consultation Draft Toward Common Metrics and Consistent Reporting of Sustainable Value Creation prepared by the World Economic Forum in collaboration with Deloitte, EY, KPMG and PwC.
EU focused funds will also be faced with the new European Disclosure Regulations governing transparency requirements of both UCITS management companies and AIFMs. Whilst the introduction of these regulations is to be staggered, most of the requirements will apply from March 2021.
Requirements contained in the regulations cover all fund managers whether or not they are managing ESG funds or sustainable investment objectives. Disclosure will include details on the sustainability risks that are integrated into the investment decisions and the impact of these risks on returns. If they are considered not to be relevant then reasons why must be given.
At this stage, it seems that the UK Government has yet to confirm whether the regulations will apply in the UK. However, at the very least it is anticipated that measures will be implemented that align to the UK’s Green Finance Strategy.
The tools needed to collate and report ESG data are improving all the time but the standardisation of reporting is maturing. Following the launch of the Global Reporting Standards in 2000, 80% of the largest corporations globally now use GRI Standards to report on their sustainability impact. Also, the International Integrated Reporting Initiative (IIRC) and Sustainability Accounting Standard Board (SASB) has developed sector specific reporting. This has enhanced relevance to investors.
Better technology enables transparency and it makes handling data easier, faster and ever more accurate. As Michael R. Bloomberg was quoted as saying: “Increasing transparency makes markets more efficient, and economies more stable and resilient.”
This is an area in which Jersey is well placed to support fund managers. Fund services businesses in Jersey have decades of experience handling large quantities of data from multiple sources and have invested heavily in technology that offers data aggregation and analysis. Just take the introduction of the AIFMD depositary services that Jersey took up with ease through the use of existing technology and in-house expertise. These technologies can be easily re-tooled to support investment funds’ ESG reporting needs, making Jersey well placed to lead from the front.
- SRI/ESG Timeline
- 2000: Global Reporting Standards launched
- 2004: Letter by UN Secretary General Kofi Annan to 50 CEOs of major financial institutions inviting them to integrate ESG in the capital markets
- 2005: Who Cares Wins published by Ivo Knoepfel suggested embedding ESG makes business sense
- 2005: Freshfield Report produced by UNEP/FI linking ESG to investment valuations
- 2007: Sustainable Stock Exchange Initiative (SSEI) integrating ESG into analysis/decision making.
- SSEI (supported by Geneva UNCTAD) grown such that many exchanges now mandating ESG disclosure for listed companies or providing guidance on how to report on ESG issues.
- 2018: GRI Standards used by over 80% of the world’s largest corporations
- 2020: Consultation Draft Toward Common Metrics and Consistent Reporting of Sustainable Value
- Creation by the World Economic Forum
- 2021: EU disclosure requirements on ESG and sustainability