Sustainable investing, or ESG (environmental, social and governance), is not a new concept. It has had many incarnations over the years. You may remember the “ethical investor” checkboxes on facts found by clients or, more recently, your focus may have shifted to climate, environment and the role finance can play to support the transition to a net zero economy.
Whatever you personally think of this type of investing, there is no doubt that it is more than just a fad and advisors need to be prepared.
Sustainability or ESG?
While ESG and sustainable investing share the same concepts and the two terms are often used interchangeably, there is a very subtle difference. Perception.
Sustainable investing can mean different things to different people, while ESG has very specific criteria that companies can measure and report on.
The data-driven nature of ESG investing offers more than just green credentials. Search for tThe European Securities and Markets Authority suggested in April this year that funds with an ESG strategy may offer better value because they outperformed their non-ESG peers and were, on average, cheaper.
Increased consumer awareness and a strong legislative drive to be more sustainable mean that questions have been raised about the integrity of some of the ‘green’ claims made by financial companies.
Greenwashing is characterized as giving the false impression that products are environmentally friendly, when there are no facts or figures to back up these claims. The International Consumer Protection Enforcement Network recently discovered that 40% of the 500 websites analyzed made potentially misleading green claims.
Without better information and a clear system for classifying and labeling products, the FCA believes that the growing demand for ESG investments could harm consumers.
At the end of 2021, the regulator presented its first proposals for a Sustainable Disclosure Requirement (SDR) and investment labeling framework. Its goal is to help consumers and institutional investors make informed decisions.
- Sustainable Disclosure Requirements: Companies will be required to report on their sustainability risks, opportunities and impacts. The initial information will aim to help retail investors make informed choices. It is intended that these disclosures be distributed with existing documentation, for example, KID.
Labeling of investments: Some products will need to display their sustainability features. This will be based on an agreed standard, allowing consumers to compare and contrast suppliers. The following labels have been proposed:
- Sustainable: Products with this label must pursue specific sustainable characteristics, themes or goals, as well as financial return.
- Responsible: This could indicate that an investment manager has considered sustainability risks as part of the investment process and risk management of a product. However, it does not have specific ESG objectives.
- Not presented as sustainable: A product in this category would have no criteria related to sustainability, even under risk management. This label would be awarded to products that have a specific investment strategy or track an index, but have not prioritized sustainability.
At the time of writing, the consultation paper dealing with comments on these proposals had been postponed until September.
Why does this affect you?
Almost two-thirds of participants in the FCA’s 2020 Financial Life Survey admitted they were worried about the state of the world and felt personally responsible for making a difference. These beliefs are already influencing people’s investment decisions.
In May this year, the Investment Association reported £1.2bn of inflows into responsible funds, bringing the total under management to £86bn.
Quite simply, if you don’t consider sustainability, you risk alienating a growing proportion of potential investors who want more than just making a profit.
While the FCA has sustainability on its regulatory radar, there’s no point when a client asks you about ESG investing now.
Vicky Pearce is director of B-Compliant