Asset managers have their work cut out meeting the ESG criteria (Environment, Social, Governance) in all facets of their work. A worldwide survey conducted by PwC among investors, titled Asset and wealth management revolution, shows that ESG is a top priority.
"ESG has become absolutely essential", is how Patrick Heisen of PwC summarises one of the conclusions of the report. "The relevant question is no longer whether asset managers should work with it, but how they should work with it. ESG not only needs to be embedded in the strategy and business model, but also in systems, processes, risk management, reporting and all other aspects of day-to-day operations."
There are a number of reasons that explain the growing importance of ESG. First of all, new legislation and regulations are forcing institutional investors to take account of ESG aspects. For example, the European guideline for pension funds IORP II, which was revised in 2017, requires that from 2019 these funds report whether they have integrated environmental aspects, social factors and governance factors in their entire investment cycles.
The Solvency 2 guideline for insurers and the EU Action plan for financing sustainable growth are further examples of new legislation and regulations. The latter contains regulations and directives that allow financial institutions to help the European Commission realise its ambitions to finance sustainable and inclusive growth, better manage climate change risks, materials scarcity and social issues, and promote transparency and a long-term focus in financial decision-making.
A second reason for the growing importance of ESG is the increasing influence of the various investments on yield and risk. "More and more asset managers, and certainly Dutch asset managers, are working to integrate ESG in their investment decisions", says Heisen. "Previously, it was possible to view ESG as something extra you could do to improve the world. Research has since unmistakably demonstrated that taking a company’s ESG rating into account in your selection process positively impacts the yield of your investments."
But ESG is also becoming more important on the flip side of the coin: part of the risk management conducted by asset managers is, for example, identifying climate risks or investigating a portfolio’s resilience to a specific energy transition.
A third reason to introduce ESG in company operations is because that is what clients are calling for. "For example, pension funds and insurers in the Netherlands have signed the Climate Agreement and have committed themselves to reporting on the climate impact of their investments from 2022, among other measures. Owing to the size of the assets represented by these parties – in the Netherlands institutional investors account for 90% of invested capital – such an obligation places serious pressure on asset managers. This translates into new requirements."
"ESG not only needs to be embedded in the strategy and business model, but also in systems, processes, risk management, reporting and all other aspects of day-to-day operations."
The question sometimes arises whether ESG is not in fact mainly a European concern. The answer provided by the aforementioned PwC survey is a categorical ‘no’. While it is true that European investors assign greater importance to ESG (7.8 on a scale of 1 to 10) than American (6.6) and Asian (6.3) investors, ESG is one of the top three asset management priorities on all continents.
"I am particularly struck and pleased by the results for Asia. A couple of years ago, ESG would definitely not have featured in the top three", says Heisen. "It is true that some people view ESG as something that is mostly important in Europe. But more and more people are realising that you don’t need to be a ‘believer’ to take ESG seriously. It is becoming increasingly clear that including ESG criteria in your investment policy will have a positive impact on your financial results and that ignoring them can lead to financial risks as well as reputational damage."
If the survey were to be repeated in five years’ time, would ESG still be the third in the list of priorities, or would it be even more important? "I am convinced that by then, ESG will no longer be measured separately, but will form a single category together with risk & return. ESG is going mainstream. In a few years it will simply be impossible to think about yield and risk of investments without seeing ESG aspects as an integral part of the whole picture."
Integrating ESG in management, investment and reporting processes will, however, require a significant effort from asset managers on many fronts. "One of the keys is data", says Heisen’s colleague Lex Huis in het Veld. "‘With unambiguous data, clear modelling and presentation of the data, it is possible to gain a useful and meaningful insight into performance in terms of ESG. With areas such as IT integration and IFRS implementation, many asset managers have observed how challenging it can be to get data quality and data management to the requisite level. Yet, integrating ESG demands even more from them than this. The speed of legislative change is considerable and the visible effect of the changes is more marked than was previously the case. Furthermore, we need more than the institutions to change; clients and investors will also need to undergo transformation. That is the only way to achieve eventual changes in the real economy."
A further remarkable conclusion in the survey is that asset managers fall most short in the aspect of operational strength, given what institutional investors expect of them in this specific area. At the same time, these investors consider this the most important criterion for assessing the performance of asset managers. This result, combined with the need to implement ESG, means that asset managers will have to focus intensively on creating a future-proof operating model. We will take a closer look at this development in a following article.
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