7 ESG investing terms you should know

It is clear that the num­ber of respon­si­ble and sus­tain­able invest­ment funds is only going in one direc­tion: up. Accord­ing to the Invest­ment Asso­ci­a­tion, UK retail investors poured more than £7 bil­lion into these funds dur­ing the first ten months of 2020.

But leg­is­la­tion regard­ing envi­ron­men­tal, social and gov­er­nance (ESG) invest­ing is less straight­for­ward. In the void, mul­ti­ple def­i­n­i­tions, acronyms and indus­try body ini­tia­tives have sprung up, all work­ing to define and mon­i­tor the boom­ing num­ber of ESG funds.

With­out doubt, leg­is­la­tion is nec­es­sary, as Amy Clarke, chief impact offi­cer at Tribe Impact Cap­i­tal, warns: “In the absence of reg­u­la­tion, there is a grow­ing sense that we may be approach­ing anoth­er prod­uct mis-sell­ing scan­dal.”

Here are the most impor­tant moves from indus­try bod­ies and reg­u­la­tors to stan­dard­ise the ESG indus­try.

1. EU Taxonomy

The Euro­pean Union Tax­on­o­my for sus­tain­able finance is the most sub­stan­tive reg­u­la­tion that has chal­lenged the finan­cial indus­try on green issues.

From March 2021, asset man­agers will be required to start upping their report­ing game, stat­ing to what extent their green funds, or any fund that claims to have envi­ron­men­tal objec­tives, are aligned with the EU Tax­on­o­my frame­work.

Hele­na Viñes Fies­tas, glob­al head of stew­ard­ship and pol­i­cy at BNP Paribas Asset Man­age­ment, explains there are 32 indi­ca­tors asset man­agers have to report on, cov­er­ing every­thing from due dili­gence and remu­ner­a­tion to adverse impacts on soci­ety and the envi­ron­ment.

“This con­cept of ‘dou­ble mate­ri­al­i­ty’ is where you not only have to take invest­ment risk into account, but also the risk to soci­ety and the envi­ron­ment, and it will cov­er every­one from asset man­agers and banks to data providers and cred­it rat­ing agen­cies,” she says.

There is no min­i­mum require­ment of align­ment that a fund has to hit to be mar­ket­ed as green, unless the asset man­ag­er wants to adopt the new “Eco­la­bel” for retail investors, but even then the thresh­old has not yet been set. Instead, the Euro­pean Com­mis­sion points to “min­i­mum safe­guards” being the Organ­i­sa­tion of Eco­nom­ic Co-oper­a­tion and Devel­op­ment Guide­lines on Multi­na­tion­al Enter­pris­es and Unit­ed Nations Guid­ing Prin­ci­ples on Busi­ness and Human Rights.

Due to Brex­it, the Tax­on­o­my will only apply to UK asset man­agers sell­ing their prod­ucts to Euro­pean investors.

2. MiFID II

The Mar­kets in Finan­cial Instru­ments Direc­tive is being updat­ed by the EU to require prod­uct providers to ensure investors’ wish­es around ESG are con­sid­ered when rec­om­mend­ing a prod­uct to invest in.

“It will be com­pul­so­ry to ask clients’ ESG pref­er­ence and to match that,” says Clarke at Tribe Impact Cap­i­tal. “The only oblig­a­tion attached to the Tax­on­o­my is the report­ing side of things. The MiFID amend­ment is a smart way to get around the fact that the Tax­on­o­my has not set a min­i­mum require­ment of align­ment.”

In oth­er words, the update to MiFID will ensure end-investors do not become vic­tims of green­wash­ing and unfound­ed green claims.

3. TCFD

The Task Force on Cli­mate-Relat­ed Finan­cial Dis­clo­sures was set up by the Finan­cial Sta­bil­i­ty Board to pro­vide a way of report­ing com­mon cli­mate-relat­ed finan­cial risk dis­clo­sures that could be used by com­pa­nies to enlight­en their investors.

“A lot of the big insti­tu­tion­al man­agers have to get their heads around what sus­tain­abil­i­ty real­ly means,” says Clarke. “The work of the TCFD has pushed them to look at the lev­el of cli­mate risk embed­ded in their port­fo­lios and has put pres­sure on the indus­try in gen­er­al.”

But the UK is not a mem­ber of the TCFD. How­ev­er, this year the Finan­cial Con­duct Author­i­ty (FCA) pro­posed a new rule which would require UK-list­ed com­pa­nies to com­ply with the TCFD rec­om­men­da­tions and, if not, explain why.

Groups includ­ing the Invest­ment Asso­ci­a­tion claim the rule doesn’t go far enough and have called on the gov­ern­ment to make TCFD dis­clo­sure manda­to­ry for all list­ed firms, not just those with a pre­mi­um list­ing. The FCA com­plet­ed con­sul­ta­tion in Octo­ber and will finalise its posi­tion this win­ter.

How­ev­er, the TCFD is not the only body work­ing to har­monise how the finan­cial indus­try goes about dis­clos­ing cli­mate-relat­ed infor­ma­tion. The Inter­na­tion­al Orga­ni­za­tion of Secu­ri­ties Com­mis­sions, the glob­al reg­u­la­to­ry body, is work­ing to trans­late all report­ing frame­works, includ­ing that of the TCFD, into one mod­el which can be used con­sis­tent­ly across the board.

4. Pension Schemes Bill

At the moment, UK pen­sions have a lot of free reign, evi­denced by move­ments like the Make My Mon­ey Mat­ter cam­paign which, in the absence of oth­er require­ments, encour­ages pen­sion providers to com­mit to all their default pen­sion funds being car­bon net zero by 2050.

But the Pen­sion Schemes Bill, mak­ing its way through the UK par­lia­ment, could change things fast. It would require large pen­sion funds to dis­close cli­mate-relat­ed risks to assets in their port­fo­lios by 2022, in line with TCFD rec­om­men­da­tions.

“The bill will be very wel­come; whether it sets the bar high enough remains to be seen,” says Clarke. “ESG is a good start­ing point, but it’s real­ly an entry-lev­el activ­i­ty. The Dutch and Scan­di­na­vians are well ahead of us on this.”

A recent report from the Pen­sions and Life­time Sav­ings Asso­ci­a­tion said pen­sion providers should adopt TCFD guide­lines around report­ing and pro­vide more train­ing for pen­sion trustees on ESG issues.

5. Responsible Investment Bill

Fol­low­ing the lead of Scan­di­na­vian coun­tries, char­i­ty Share­Ac­tion and the All-Par­ty Par­lia­men­tary Group on Sus­tain­able Finance have pro­posed a Respon­si­ble Invest­ment Bill, which would increase direc­tors’ account­abil­i­ty for their invest­ment deci­sions, allow­ing ben­e­fi­cia­ries of invest­ment schemes to seek judi­cial redress.

Going much fur­ther than the Pen­sion Schemes Bill, it would require default and green pen­sion funds to align with the Paris Agree­ment, and for this to be enforced by the FCA and the Pen­sions Reg­u­la­tor. It would also force pen­sion providers to ask ben­e­fi­cia­ries about their ESG views.

“This pro­pos­al is absolute­ly ground­ed in pen­sion funds deliv­er­ing the strate­gies which are in the best inter­ests of their ben­e­fi­cia­ries, try­ing to break out beyond the strait­jack­et of prof­it max­imi­sa­tion,” says Cather­ine Howarth, chief exec­u­tive of Share­Ac­tion.

“It’s not try­ing to pre­scribe how pen­sion schemes invest, rather it takes them through a process to check they’ve thought in a more holis­tic way about strate­gies that will deliv­er the best long-term out­comes to the peo­ple they owe duties.”

6. UK Stewardship Code

A decade after the Finan­cial Report­ing Coun­cil intro­duced the UK Stew­ard­ship Code, for the first time it is now nec­es­sary for sig­na­to­ries to inte­grate ESG con­sid­er­a­tions into their deci­sion-mak­ing. The new code has also moved away from “com­ply and explain” to “apply and explain”, min­imis­ing the oppor­tu­ni­ty for green­wash­ing.

As the code states, as of 2020 sig­na­to­ries must “sys­tem­at­i­cal­ly inte­grate stew­ard­ship and invest­ment, includ­ing mate­r­i­al envi­ron­men­tal, social and gov­er­nance issues, and cli­mate change, to ful­fil their respon­si­bil­i­ties”.

7. B Corporations

Not all the pos­i­tive reform and effort is on the investors’ side. There are grow­ing num­bers of so-called B Cor­po­ra­tion com­pa­nies, totalling more than 3,500 around the world and 250 in the UK.

These com­pa­nies are like for-prof­it ver­sions of social enter­prise, plac­ing equal empha­sis on peo­ple, plan­et and prof­it. A recent exam­ple is Bookshop.org, which rais­es sales for inde­pen­dent book­shops. Some are list­ed and cer­ti­fied B Corps include sub­sidiaries of very large com­pa­nies such as Unilever and P&G.

“B Corps empha­sise a grow­ing move­ment from share­hold­er to stake­hold­er cap­i­tal­ism and in the process strength­en the link between busi­ness and soci­ety,” says Tribe Impact Capital’s Clarke.

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