Posted on: June 8th, 2018
20 June 2018 Update: Our published response can be found here.
On 24 May 2018 the EU published draft recommendations proposing the inclusion of ESG within the obligatory advice process as part of their ongoing work supporting the growth of Sustainable Finance.
Their draft text is open for feedback until 21 June.
I plan to respond directly (and am working with other such as UKSIF) – but thought I’d share my views as this is such an important development and there is time yet to respond. My view is that Environmental, Social and Governance issues matter Brexit or no Brexit – as we only have the one planet, so we need to all chip in to help make this a success.
To start with I must say that their proposals are excellent. Should any of its authors read this I would like them to know that I am pleased they have grasped this nettle – and that my feedback is intended to make this proposals as effective as possible.
The proposed amendments have the potential to drive more money towards better companies and improve clients’ investment experiences.
The amendments mean that financial services intermediaries will soon be required to discuss ESG with clients – and to demonstrate that they have the processes in place to do so properly. I believe this means clients will enjoy better, more holistic advice that reflects their interests and concerns – and give them exposure to investment strategies that are better aligned to the term of their investments. (Which is what our Fund EcoMarket site is designed to acheive.)
However I am really quite concerned about some of the – not exactly minor – detail at the very beginning of their proposed amendments.
The definition of ESG, set out on page 7, point 7 – (expanded further in points 9, 10 and 11) refers to these terms as meaning; E = ‘environmentally sustainable investment’ S = ‘social investment’ and G = ‘good governance investment’.
These definitions are (in my view) too narrow, rather naive and risk being counter-productive as they do not reflect anything like the whole picture when it comes to encouraging constructive, more ‘sustainable’ finance and the urgently needed transition towards more sustainable lifestyles (across all sectors).
The problem as I see it:
To try to avoid sounding like a complete geek (have I lost you yet?) my main ‘generic’ concerns are in summarised here in bullet form…
Focusing on the definitions the author has used, some examples of why I feel these terms risk defeating the purpose of the proposals are:
Example industries that illustrate where environmental, social and governance ‘trade-offs’ are valuable and where fund strategies may legitimately be very different include the following:
A solution, maybe:
The definition I prefer for this kind of thing is (along the lines of) ‘takes environmental, social and governance issues into account to a significant extent’. With no further explanation.
This dates back many years (to Friends’ and UKSIF days) and was commonly used for the primary reason that it does not run the risk of tying ourselves up in knots.
It keeps the door open for funds that ‘avoid the worst’, ‘favour the best’, ‘engage for change/better stewardship’ – in many and various different combinations – and so meet the diverse needs of clients.
The other part of the equation is transparency. To my mind, within reason, funds can do what they want as long as they are open and honest about their strategies and ‘do what they say on the tin’. This leaves managers free to innovate and differentiate themselves (including running ‘sin funds’ if they feel the need to do so.)
I understand the EU’s desire to have tight definitions (points 9,10,11 expand on the above and in my view make it even worse). Some of the ESG strategies we see today do appear to be limited in ambitions but high on self promotion. Some managers engage with ‘no hopers’ for years and never use the ultimate sanction of selling their shares, for example. Others set the bar so low they are hard to differentiate from ‘non ESG’ strategies.
However some strategies are blurring the lines between ESG and SRI themed funds – raising the stakes – using ESG as a baseline and building in additional screens or strategies. (I last spoke about this with a previously unknown fund manager earlier this week). Such funds can be hard to differentiate from explicitly ‘sustainability themed’ funds – and in many ways it is pointless trying to do so – although in practice their stock selection decisions are often different, the former being more large cap focused.
This area is very much ‘work in progress’ . Funds of this kind should be viewed as perfectly acceptable provided they are explained properly – with a clear emphasis on enabling clients to find the right fund for their personal needs.
Many of the funds I consider to be ESG, SRI or ethical are likely to struggle to fit within the ESG definitions set out on page 7 (they are not significantly invested in pure play / clean tech, or targeting social impacts) – and I do not believe they should try to.
Some are quite specialist whereas others are mass market funds – aimed at ‘shifting the dial’ for regular investors. I label some as sustainable, environmental or socially themed – and others as ethical funds. These reflect the funds core purpose. All consider ESG and all help direct money towards carefully selected ‘more sustainable’, ‘dial shifting’ companies (in their different ways) and all are infinitely better than ignoring these issues…
In essence – all I can do is encourage policy makers to learn from the past and keep an open mind about the future. The direction of travel (across all sectors) needs to be a central tenet of the new rules and we need to welcome all existing and future strategies that will encourage greater sustainability. We can not afford to do otherwise.
I would encourage you to keep this in mind if you are considering responding to this consultation (deadline 21 June) – particularly if you have business operations in Europe.
ps We have been here before with the EU (Dominique Be – if I remember correctly) who, with an apparently genuine interest in the area, was looking to ‘define’ (ie label and ‘approve’) ‘Ethical Investments’ many years ago. UKSIF and others pushed back as this was considered likely to stifle innovation – and the idea was scrapped. Since then we have seen an explosion of innovation including the mainstreaming of the term ‘sustainability’ and the emergence of sustainable finance plus ESG, impact investment, stewardship and numerous positively themed approaches!
We need to be less binary this time of course . We most definitely do not want the EU to back track – but we do need the text to be more welcoming to both today’s newer (and often still evolving) strategies and to those as yet unknown.
As ever – if you wish to get in touch and help shape my thinking before I submit a response you can contact me on julia@sriServices.co.uk.