ESG boom brings regulation

Aviva Investors’ sustainability experts discuss ESG’s rising popularity and the potential impact of new rules and regulations. 

steve waygood, aviva’s chief responsible investment officer

While ESG is already one of the asset management world’s fastest-growing segments, this is only the beginning. 

‘Ninety-two per cent1 of advisers believe ESG will be a large proportion of their business in two years’ time,’ says Steve Waygood, Aviva’s chief responsible investment officer.

‘It stems from a growing awareness in society. People care about the fact that we’re heading towards a four-degree future from a climate change perspective2; that 40% of agricultural land is distressed3; that 50% of the world’s coral reefs have been bleached4, and 80% of the world’s fisheries are distressed5.’

Research shows that when people invest in a way that’s consistent with their values, they invest in those products for longer and they’re more engaged with their money and their savings
Tom Tayler

As civil society places more and more pressure on governments to act, regulation will reshape the financial landscape. And two upcoming regulations in particular will directly affect advisers.

‘The Sustainable Finance Disclosure Regulation (SDFR) is all about better information about the sustainability credentials of firms and similarly, about the credentials that you use as financial advisers, when talking about them with your clients,’ says Tom Tayler, senior manager at Aviva’s Sustainable Finance Centre for Excellence.

At the same time, new rules via Mifid ll will require advisers to find out if clients have sustainability preferences that should be reflected in the adviser’s recommendations.

‘So, it will be important to understand how the products you recommend not only meet your client’s financial and risk objectives, but also what your client’s values are and that the products you recommend are suitable for the way they want their values and preferences to be reflected in their investments,’ he adds.

Greener objectives

The change is being driven not only by global regulators’ fear of greenwashing, but also by a desire to help people understand where their money is being invested and the belief that greater public understanding will catalyse the shift towards more sustainable investments, by creating demand among end-investors.

‘They’re worried about products claiming to have green or sustainable credentials when they’re not actually delivering equivalent outcomes. The disclosure regulation is designed to show who is actually walking the talk.’

This is a massive opportunity for advisers to have deeper and more involved conversations with clients, he notes.

‘That’s going to lead to them better understanding how their money can shape the world they want to retire into. Research shows that when people invest in a way that’s consistent with their values, they invest in those products for longer and they’re more engaged with their money and their savings6,’ he says.

The challenges of climate change are huge and intrinsically linked to the profitability of clients’ investments, Waygood points out.

‘The embedded global warming potential of the London stock exchange today is 3.8 degrees7, five years after the Paris agreement, which crystallised the aim of a 1.5-degree world. Getting that back on track will require a profound change to the economy.

‘The end user needs to know they, and their investment managers, have the opportunity to make more money via a better understanding of how ESG issues affect the future returns of any given security.’

It’s vital to make sure that providers have a transparent and effective approach to engagement and integration
Steve Waygood

In other words, ESG integration is about maximising long-term, risk-adjusted returns within active fund management. Advisers need to make sure the provider has an excellent approach to integrating ESG. On top of that, individuals need to understand that the best financial method to power a transition to a more sustainable future is to use ownership influence and voting rights at annual general meetings.

‘It’s vital to make sure that providers have a transparent and effective approach to engagement and integration,’ Waygood says.

Three questions with Thomas Tayler, senior manager at the Aviva Investors Sustainable Finance Centre for Excellence

1. Isn’t ESG a fiduciary duty and not an impact or ethical solution?

In our view, ESG absolutely could be seen as a fiduciary duty for anyone in any part of the asset management chain. Fiduciaries are, after all, required to consider all financial material when making investment decisions, and it has now been established that ESG factors have the potential to be material in investment terms. So, closing one’s eyes to these factors could be argued to be a breach of fiduciary duty.

In our view, the existing obligations laid out by regulators, whether it’s the FCA in the UK or the European commission, already require you to incorporate ESG factors, even without the clarification of SFDR and the like. But that doesn’t mean you can’t also use ESG criteria to create impact, for example, as long as you can show you’re doing something measurable.

Traditionally, ethical investing was all about screens, whereas there are now many ways in which investment strategies can incorporate ESG, which might include seeking a financial outcome while taking a best-in-class approach to ESG issues, or demonstrating a measurable sustainability impact alongside the financial objectives of a product.. There are so many different possible ways that ESG data can be used that the Venn diagram of how they overlap is quite complicated. But perhaps the key point is that there is almost a baseline fiduciary expectation to incorporate ESG into any investment decision.

2. Should advisers encourage investors towards ESG investing or remain neutral and allow clients to express whether they have concerns or views?

It might be for the client to lead but at the moment, I’d say that the majority of people don’t currently know they can reflect their values in the ways they invest. Even if they do, they don’t know how to go about it, and there’s a massive role for the advice community to play in up-skilling them.

It’s about advisers having a deeper conversation with clients that covers all the possibilities. Not just the questions we all know about return expectations, risk appetite, savings goals and so on, but also, do you want to take climate change into account? Do you care about biodiversity? Do you care about human rights? Because there are products now that can be used to achieve a financial return and have those values reflected. As more and more ESG products come to market, there’s a great opportunity for advisers to blend portfolios to reflect these preferences.

3. You mentioned new regulation. Mifid and European regulation has yet to be implemented by the FCA at the ‘adviser level’. Do we have a timetable for this?

It’s correct to say EU changes won’t apply automatically in the UK. But as mentioned in the module, the Treasury and the FCA have said that we will at least match the ambition of the EU. Based on that, it seems we may not follow the rules verbatim but we will reach the same outcomes and, in some cases, go further.

While there’s no timetable yet for how that’s going to work, we would stress that there is nothing to stop an adviser asking these questions now. It’s completely consistent with existing rules and there are a number of studies that show customers do respond positively to these questions. Aviva Ireland’s studies have shown that when two products are placed side by side, 80% of people pick the more sustainable option. A UK government study found that 75% of people wanted to invest more sustainably and that they would save more if they felt their savings were in tune with their values. So, it’s in advisers’ interests to have these conversations.

This article first appeared in Citywire NMA

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