How ESG is shaping the funds industry

Written by: Dr Desne Masie Posted: 20/11/2019

BL65_ESG photo-illoFrom investor demand to public opinion to policy developments, the funds sector is having to juggle multiple influences as it seeks to build robust ESG frameworks for a more ethical era of investing

Political and economic instability arising from inequality, climate change and migration is beginning to affect the sustainability of the business environment to degrees too significant to continue to ignore. 

To mitigate the impact of instability on investment returns and economic growth, environmental, social and governance (ESG) factors are increasingly being taken into consideration by institutional and private investors in alternative and vanilla funds.

Demand for ESG investing is being further reinforced by the realisation that responsible capital presents a tangible way to address global sustainability concerns while also producing more robust long-term investment returns. 

Not only does this reconfiguration of attitudes to capital present challenges and opportunities for the Channel Islands funds industry, but it is also ultimately changing the way that funds are structured, administered and managed. 

“This shift is undoubtedly being driven by global macro trends,” says David McNay, Director and Head of Funds at Zedra Guernsey. “Society in general is moving much more towards impact investing. Consumers are driving the shift in businesses, and people are more comfortable working in businesses that are sustainable.

"We are keenly aware of ESG as part of what we look for when we are setting up a structure or an investment solution now, as these strategies also provide a good investment return over the long term. [Launching an ESG solution] is absolutely part of our conversation.” 

Kevin Smith, Director at Estera International Fund Managers (Guernsey), echoes this: “The [funds] business is changing, and it is changing very rapidly. 2018 was a big catalyst point for many things – particularly green issues, compounded by the Attenborough effect and the Greta effect – all coming together in the ESG space.” 

Professional services providers and administrators are already beginning to see more due diligence questions on ESG coming from clients about their operations. 

At the moment, administrators are more routinely subject to this shift than other service providers, but across the board, businesses are going paperless and offsetting their carbon footprints to signal they are not only ‘norms-takers’ but very much ‘norms-makers’ with regard to ESG. 

Green finance leader

Guernsey has been particularly agile in positioning itself as a leader in green finance. Its green funds framework, introduced in July 2018, is now well established, with $4bn under management. The first Guernsey green fund was oversubscribed, clearly showing that the opportunity is making ethical and commercial sense to investors. 

Government and industry in Guernsey are now trying to move the application of ESG factors along in a few other key areas. For example, the Environmental and Social Impact Monitor recently co-developed by Justin Sykes, Managing Director of Innovest Advisory, is being widely touted as a way for funds to benchmark themselves against, and contribute to, international standards. 

The decision by Generation Investment Management – the firm co-founded by former US Vice President and climate activist Al Gore – to domicile its $1bn Generation IM Sustainable Solutions Fund III in Guernsey has been a boost for the bailiwick’s ESG credentials.

Structured by offshore law firm Mourant and launched in May 2019, Fund III will invest between $50m and $150m in companies helping the health of the planet or individuals, or those driving financial inclusion. 

Darren Bacon, a Partner at Mourant who was instrumental in the transaction, says: “They could have put that fund anywhere, but they chose to put it offshore, and to set up the fund in Guernsey.” 

Given the wider global conversation about the contribution of tax-neutral international centres to global inequality, and the profile of Al Gore within ESG circles, the formation of the Generation Fund on Guernsey helps the Channel Islands’ efforts to be transparent about their tax-neutral strategies. 

It also contributes to positioning them as highly skilled, well-run jurisdictions that provide funds – predominantly pension funds and public bodies – with wider operating margins and higher investment returns. 

BL65_ESG photo2Socially responsible investing

Jersey is putting responsible and impact investing more firmly on its financial services agenda and has a strong showing on the ‘S’ in ESG. The island administers more than 30 socially responsible investment (SRI) funds and has attracted 41 new registered charities since its Charities Law came into force in 2018.

Jersey Finance cites a number of factors that make the island an SRI hub, including a wide range of flexible structures, fund administration excellence, and unrivalled knowledge and expertise.

Jersey’s credentials are also supported by the presence of investment manager Rathbones, which has operations on the island and has long offered bespoke ESG investment solutions through Rathbone Greenbank Investments, established in 2004. However, ESG considerations have become part of the groupwide DNA. 

Victoria Hoskins, Investment Director at Rathbone Greenbank, explains: “As at June [2019], we had £1.5bn of our discretionary managed assets just in our Greenbank team for the Rathbones group. That doesn’t take into account the £49.4bn as a group where managers also incorporate negative screening into portfolios and use MSCI screening to get a baseline ESG level.” 

Tim Ford, Rathbones’ Investment Director in Jersey, believes that this degree of transparent reporting on ESG assets under management is valued by investors, which helps the company set itself apart from competitors.

Pan-island, The International Stock Exchange (TISE) is setting the pace for listed funds, having recently introduced its green segment. According to TISE Group CEO Fiona Le Poidevin, the transparency and good governance principles reinforced by ESG investing are at the core of the exchange’s listing process. 

TISE’s focus on ESG puts it right up there with other leading markets, including London Stock Exchange (LSE). Darko Hajdukovic, Head of Fixed Income, Funds & Analytics, UK Primary Markets at LSE, says: “There are now 22 green and renewable funds on our markets, raising over $10bn, deploying capital to meet universal renewable targets. More than 130 green, social and sustainability bonds are currently listed on London Stock Exchange, raising over £27bn.” 

Examples of ESG-focused capital-raising at LSE in 2019 include: Aquila European Renewables Income Fund, which raised $172m to invest in continental renewable energy infrastructure; the US Solar Fund, which raised $200m; and The Renewables Infrastructure Group (TRIG), which raised $676m across two capital raises to help further expand its investment portfolio. 

The move to ESG investing looks set to rise and rise, according to the 2019 Smart Beta survey from LSE’s FTSE Russell – 77% of European asset owners taking part in the survey stated that they plan to apply ESG to their strategy. 

Process of normalisation

Wayne Atkinson, Group Partner at Collas Crill in Guernsey, has worked on green loans in fund financing. He thinks this trajectory is only likely to increase as ESG frameworks become standardised and, ultimately, entrenched. “There is a process of normalisation taking place to develop a best practice framework for incorporating ESG principles into funds formation and management, in a similar way to how corporate governance has evolved.” 

Annette Alexander, a Partner with Carey Olsen, who has been involved in social impact funds and several green funds, sees it from a capital-raising perspective, “whereby prospectuses are being changed to incorporate ESG factors, and in constitutional documents to incorporate ESG reporting”. 

Given the scale of the ESG-related opportunities presenting themselves to the funds sector, the likes of Estera are pushing on with efforts to upskill. 

As Kevin Smith says: “We already have [ESG] champions in each business. We need to learn all the time about the reporting requirements and have training courses informed by the international networks. We support this across the industry, not just at Estera.” 

Woefully unprepared?

Despite all this activity, should funds be moving much more quickly to consolidate their ESG frameworks? Andy Sloan, Deputy Chief Executive, Strategy at Guernsey Finance, says it is a matter of time before ESG becomes the normal way in which business is done. He fears the industry is woefully unprepared. But the drag on implementation may be due to the degree of regulatory discretion still allowed. 

While a long list of high-level policy developments (see timeline below) are beginning to filter into best practice, many are voluntary. Sloan believes they will eventually become more explicitly required in law and regulation. 

With so much of the ESG framework under development, ‘greenwashing’ – making a company or fund appear more environmentally friendly than it really is – remains a concern in the race to win mandates or signal virtue. However, on both islands, concerted efforts are being made in the funds sector to adhere to best practice.

ESG-related policy developments

2006 The United Nations (UN) publishes its Principles for Responsible Investment 

2010 The British Private Equity & Venture Capital Association publishes its first Guide to Responsible Investment

2015 International group the Financial Stability Board establishes Task Force on Climate-related Financial Disclosures

2016 The UN’s Sustainable Development Goals come into force and the Paris Agreement commits signatories to strengthening the global battle against climate change

2017 Network of Central Banks and Supervisors for Greening the Financial System (NGFS) is set up by eight central banks and supervisors

2019 EU sustainable finance reforms approved by the European Parliament; UK Financial Conduct Authority proposes improvements to climate change disclosure by issuers and to green finance information for consumers

 


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