Change of ESG approach by ESMA welcomed by asset managers

Fears that asset managers would be forced to arbitrarily unwind positions in non-sustainable companies have broadly subsided following ESMA’s announcement.

By Charles Gubert

The European Securities and Markets Authority (ESMA) has seemingly put on hold the idea of pursuing a prescriptive approach towards its ESG (environment, social, governance) policy initiative in favour of a more principles-based method.

The regulator said proposals for asset managers to integrate sustainability risks into their investment decision-making should be flexible, according to a consultation released at the end of December. The clarification will be welcomed by fund managers, a number of whom were initially alarmed that the initial proposals appeared to be overly rigid.

Conscious of the growing investor demand for ESG products and the genuine need to encourage financial institutions to play a meaningful role in meeting the objectives outlined in the Paris Climate Agreement, the European Commission (EC) announced an Action Plan on Sustainable Finance in 2018.

The proposals recommended asset managers integrate sustainability into their investments, and laid down a framework to create a watertight ESG taxonomy, a tool which could be used by clients to benchmark managers on their sustainability and eliminate the risk of greenwashing arising.

However, fears that asset managers would be forced to arbitrarily unwind positions in non-sustainable companies – along with concerns about adhering to an excessively uncompromising taxonomy – have broadly subsided following ESMA’s announcement.

Firstly, ESMA acknowledged that rigid ESG rules were inappropriate given that sustainable investing is still a fairly embryonic strategy subset and a continuously evolving one at that. It also conceded such a policy would put Europe at a competitive disadvantage by creating barriers to ESG market development.

Furthermore, ESMA said the integration of sustainability risks within UCITS and AIFMD (Alternative Investment Fund Managers Directive) “is better done through a high-level principles-based approach similar to that already followed for a number of other relevant risks such as interest rate or credit risk.” ESMA is therefore recommending that impacted fund managers incorporate sustainability risks into their standard investment due diligence processes.

Nonetheless, ESMA stated investment managers will need to rewrite some of their firm-wide risk management and due diligence policies and procedures in accordance with the rule-changes.

“Authorised entities should carefully consider whether they have sufficient human and technical resources for the assessment of sustainability risks within their organisation and governance structure. It is important that authorised entities employ individual(s) that possess the relevant skills, knowledge and expertise in sustainability risk,” added the ESMA consultation.

The pursuit of ESG mandates is a big business for fund managers, with sustainable strategies accounting for around $22.9 trillion, according to the Global Sustainable Investment Alliance, and is forecast to grow even further.

State Street Global Advisors’ research found 50% of ESG investors plan to increase the degree to which they incorporate ESG into their portfolios over the next three years, while 23% of non-ESG investors intend to add ESG. Notwithstanding ESG demand among millennial clients, asset managers see sustainable investing as a tool to fill the capital raising void.