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ESG - Challenge and Opportunity

Jack Payne | 19 January 2021

Questions for leaders in the buy-side looking to integrate ESG

In recent years, we’ve observed how environmental, social and governance (ESG) factors have driven decision making across the buy-side. With increased awareness around climate change, cancel culture hitting ESG offenders, plus signs that COVID19 has increased our focus on social issues, it’s clear that ESG is more than just the flavour of the month and buy-side firms must embrace ESG for fear of being left behind.

The raw numbers:

  • According to the Investment Association, net in-flows to responsible investment funds in the first three quarters of 2020 were up 275% from 2019 (£7.1bn). This leaves the total amount invested into responsible investment funds at almost £800bn, another all-time high.
  • UK fund flow data from Calastone found that investments into actively managed ESG funds between April and July 2020 exceeded the combined flows for the previous five years.
  • Global ESG fund launches are up, with 166 new fund launches in the third quarter of 2020, breaking the previous record of 159 set in Q4 2018.
  • The number of funds adding ESG obligations rocketed to 500 in 2020, up over tenfold on the year before (although this could be due to managers greenwashing their funds to stay ‘on trend’).
  • Against MSCI’s five ESG indices, all UK ESG funds outperformed their parent index in 2020 and further research from Blackrock stated 94 per cent of a globally representative sustainable indices outperformed their parent benchmarks during the pandemic.

The departure towards a more ESG focussed future is clear for the buy-side and it’s been driven by its client base. ESG is a different set of data, a new way to communicate with clients and a new thought process that goes beyond simple past fund performance.

So, what questions should leaders be asking… at the firm level?

Is ESG fully embedded within the corporate strategy?

High-performing financial services organisations with ESG at their core need to espouse the same ESG criteria as they look to invest in. Assessing maturity, then implementing an effective strategy with a robust ESG target operating model, roadmap and governance framework will be critical.

Is the ESG narrative aligned internally across the organisation?

From investment teams through to HR, all business functions will need to unite to ensure a consistent narrative is ingrained into the organisation to enable cultural change. Consistent training and internal communications will be crucial.

What message should be communicated externally?

Current trends suggest the next generation of investors are more than twice as likely to make investment decisions based on a business’ sustainability. As such, firms will need to consider how they market their ESG credentials, for example committing to the UN Global Compact, going carbon neutral and meeting D&I targets.

How will ESG reporting requirements change?

What developments, metrics and KPIs are required to ensure the ongoing delivery of ESG performance? The compliance is also coming. With changes to MiFID II, AIFMD and with TCFD being mandatory in full by 2025 (and in part by 2023), what additional changes must be made?

…at the fund level?

How fit for purpose are front office data, thematic frameworks, portfolio analytics and research tools to return maximum value to clients?

As new ESG funds launch, what improvements should be made to ensure clients receive genuine value for money? In an era of shrinking margins, market-leading investment tools provide an opportunity to double down on the growing AUM channelled into ESG by providing best-in-class active management - something clients are willing to pay for.

What changes are required to risk management policy and process?

Competitors in the buy-side are already agreeing to divest from companies that have failed to meet its ESG standards (see Standard Life’s recent £440m divestment plan). So, what decisions can be made to improve risk exposure across portfolios when factoring in ESG?

Is the product and marketing approach fit for purpose?

Reports on ‘greenwashing’ have raised concerns over the legitimacy of ESG ratings. So, what improvements must be made to marketing, KiiDs, client preference factfinding and annual review processes to ensure clients have transparency around products and securities?

The profound growth of ESG poses both a huge opportunity and a huge challenge for firms to integrate ESG into their everyday practices. With COP26 scheduled for 2021, the foot remains firmly on the ESG accelerator. The winners will be putting ESG at their core, so leaders should be asking “is our business ready?” and “what can we be doing better?”.

Jack Payne is a consultant at Interim Partner at NSCG's Financial and Professional Services practice. As market leaders in asset and wealth management change, we help accelerate performance through leadership & talent solutions. To learn more, please get in touch.