Asset managers seeking a coherent ESG strategy first need a coherent narrative
ESG investing – like many areas of investment – has a ‘saying-doing’ gap; the reality does not always match the marketing spin. But in ESG there is a second gap, one that perhaps we are less familiar with. We might call this the doing-impact gap. How can we tell whether what we are doing is having the intended effect?
As ESG embeds itself ever more into the investment mainstream, the doing-impact gap becomes more conspicuous. As a result, the reporting of ESG outcomes by asset managers has become a growing focus.
The most immediate pressure comes from the EU’s regulation on sustainability-related disclosures in the financial services sector (SFDR), most of which comes into force in March 2021. But there are several other factors helping to bring this issue to the fore. Initiatives such as Task Force on Climate-related Financial Disclosures (TCFD), CDP (formerly the Carbon Disclosure Project) and Sustainability Accounting Standards Board (SASB), are pushing corporates towards better disclosure. Better data and growing demand have, in turn, spurred the development of a richer range of analytical tools and ratings. And client interest is snowballing.
So firms need to take this development on board. This does not apply only to ESG specialists. Certainly, it is a bigger question for them. But while the EU regulation, for example, specifies more detailed obligations for ESG-related products, it imposes a number of disclosure requirements on all asset management firms that market products in the EU. And while client expectations around reporting are, likewise, more extensive for ESG-related products, improved disclosure is likely to become the norm across the board.
We must be realistic about what is possible. Meaningful reporting is a more complex and ambiguous task than traditional performance reporting. ESG outcomes can involve many measures; what is measurable might be only indirectly related to the end objective; and there is usually no natural point at which to draw the line between success and failure. And since technology, the regulatory landscape, and corporate reporting are all changing fast, this work is going to take some time.
Pros and cons of standardisation
Dealing effectively with these challenges requires finding the trade-off between standardisation and flexibility. This does not come easy. Consider, for example, the EU’s SFDR regulation. From March 2021, asset managers will, among other things, need to disclose their policies regarding: how sustainability risks are incorporated into the investment decision-making process; and the principal adverse impacts of the decisions on the environment – in areas such as carbon emissions or biodiversity – and on social factors such as human rights and the gender pay gap. In addition, no fewer than 50 additional quantitative disclosures have been proposed.
There are many advantages to standardised reporting. Producers of reports know what is expected of them. Output is easier to understand, and can be compared across providers. Standards can make it harder to pull the wool over people’s eyes, offering protection against some of the more blatant forms of greenwashing, for example. But it is an unenviable task to set rules for disclosure that minimise the scope for gaming the system, that are practical and meaningful, and that recognise the dynamism of the situation.
For example, policy disclosure such as that required by SFDR is a good start, but having a policy does not guarantee good outcomes; Enron had policies, as did VW and Theranos. And things get really thorny when we look at the proposed quantitative disclosures. There are practical barriers; the data required from investee companies is not mandated in every case, even for EU-listed corporations.
Some of the disclosure is material only for certain sectors. Deforestation policies, for example, are a material consideration when investing in a resource company, but not a tech company. So disclosing the share of investments in entities without a deforestation policy – as would be required under the current proposal – has limited value.
Standards are harder to define in an environment that is complex or dynamic. The ESG field is both.
Asset managers need a narrative
Regulators and others involved in establishing the rules and norms of reporting need to manage the tension between standardisation and flexibility, and they need to be responsive in dealing with emerging possibilities and emerging challenges.
Progress is possible, as illustrated by the welcome recent announcement of closer co-operation between five of the organisations that have been leading the charge on standardisation of sustainability reporting by corporations, an area which has been hampered in the past by the absence of common standards.
But where does all this leave the asset manager? Clearly, regulatory requirements need to be met. So SFDR will be top of mind for most in the short term. But it is not a good idea to leave your strategy to the whims of the regulators; you will end up bobbing along like a cork on the ocean. Worse, the task becomes merely an administrative chore. Well-crafted reporting, however, can be a platform for stronger client engagement, helping to build deeper and broader relationships.
To achieve that takes more than raw numbers. You also need a narrative that ties the numbers together. This is how you let clients know what ESG factors you see as material. This is where you remind them how the ESG outcomes relate to your investment approach – something unique to your firm.
A strong narrative is only possible if there is a clear understanding of what your ESG efforts are intended to achieve. If you have never developed clear ESG beliefs, or if they have been overtaken by the fast-changing landscape, a beliefs exercise can be invaluable in framing the whole programme. Such an exercise can guide what you should be emphasising in reporting, and add the necessary context for using data to create engagement with clients.
Plenty of work to do
Asset managers also need to be aware of the wider conversation on this topic, because it is sure to keep developing. The UNPRI and the CFA Institute each have reporting initiatives, for example. For insight into the current state of the art, the Impact Management Project is another resource worth tracking.
While there are deeper questions around reporting for ESG-related products, the same principles apply – only more so. Effective reporting starts with clear beliefs, and requires context to give meaning to the numbers.
In summary, we are still in the early stages; data and tools will improve significantly in the coming years, and norms will move on. As this happens, better reporting of ESG outcomes will help to close both the saying-doing gap and the doing-impact gap.
Bob Collie is principal at Collie ESG. He advises asset managers and investment organisations on best practice in ESG and sustainable investing
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