Everybody’s talking about ESG – environmental, social and governance – but is it just a passing fad or is it really ready to enter the mainstream arena
“Managing climate change risk is not about bunny hugging.” Those were the words of UK Prime Minister Boris Johnson, addressing a virtual summit in April that also saw many of the world’s leaders commit to new carbon emission targets.
While Johnson’s remarks may have been met with some derision, they reflect a deeper and growing commitment by the world’s decision-makers to protect the environment.
This pressure from the top is also driving a renewed focus on sustainable finance, with a deluge of regulations filtering down from on high – particularly in Europe – aimed at improving disclosure and transparency.
In addition to compliance with EU rules, the Task Force on Climate-Related Financial Disclosures (TCFD) has provided a framework to help companies be more transparent on their environmental risk.
Bradley Davidson, ESG Manager at RBS International, says: “Disclosure frameworks such as TCFD or SFDR [the EU’s Sustainable Finance Disclosure Regulation] are becoming regulatory requirements and will ensure these impacts will continue to be accounted for.”
Moving to the mainstream
Rules aside, it can also make good business sense to capitalise on the growing appetite for environmental, social and governance (ESG) investment strategies.
During the Covid-19 pandemic, ESG-driven investment strategies outperformed their traditional peers. Index provider S&P Global analysed the returns from 26 ESG exchange-traded and mutual funds covering $250m in assets. In the year to 5 March 2021, 19 of these funds saw increases of between 27.3% and 55% compared with 27.1% from the S&P 500.
Jamie Mourant, Investment Manager at Brooks Macdonald International, says that while there will always be investors who shun ESG investing as potentially damaging to returns, there is a notable shift towards those who believe that incorporating sustainable investment principles will enhance performance.
Mourant says: “In the midst of a global pandemic, when global markets were experiencing one of their worst quarters on record, there were still net inflows into ESG and sustainable funds of over $40bn – compared with around $385bn net outflows from the wider fund market.
"This counters the theory that the interest in ESG and sustainability is a fad or an extravagance for when markets are doing well – and that people will move away when there are market and/or economic downturns. Instead it indicates a structural shift.”
Check the label
So, the spoils are there for providers offering truly genuine funds. But what about those who see the trend to sustainable investing as an opportunity to asset grab?
Greenwashing – labelling bog-standard funds as sustainable – is the bugbear of those committed to ESG investment; and it is on the increase.
As Mourant points out: “The rise of many new niche ESG-type funds poses a greater challenge on both how to spot and avoid strategies that over-promise and under-deliver on ESG and sustainability characteristics.”
Research from Morningstar found that 505 sustainable funds were launched in Europe in 2020, as providers sought to cash in on a market accelerated by investor interest in climate change.
In response, Jersey Finance is committed to recognising and, where possible, eliminating greenwash.
Charlotte Brambilla, Associate Director, Financial Services, at the Government of Jersey, says: “The regulator is obviously taking greenwashing seriously. We are taking a deliberate approach to sustainable finance, which has got to deliver against the ESG objectives Jersey has tied itself to.
“The last thing we want to do is enable a whole load of businesses to come to the islands using sustainable finance as a marketing wheeze, and not delivering against objectives.”
Standardisation issues
Managing greenwashing is not the only challenge for ESG advocates. There also remains a stubborn lack of standardisation when it comes to terms – and even what it means to be sustainable.
Craig Cordle, Partner at Ogier, says: “Different regulatory bodies and industry players have their own understanding of what sustainable finance means.
“Add this to the absence of any global, standardised regulation for sustainable finance, and what you have is a complex landscape that can frequently be confusing for investors.”
However, as part of its European Green Deal, the EU is creating green taxonomy that will provide more clarity and more universal definitions around all things ESG.
For RBSI’s Davidson, acceptance of ESG into the mainstream is welcome, but it has been a long time coming. While there may be a spotlight on sustainable finance now, he says, it is not a passing fad.
“Even after the spotlight is gone, we should be left with a robust set of requirements that ask all market participants to consider wider impacts, such as environmental or social, which ensure their investment decisions are well informed,” he says.
Sustainable Finance Disclosure Requirements: putting the green into black and white
In March 2021, the EU imposed mandatory disclosure requirements for financial organisations offering ESG products. There are two levels of disclosure: level one gives the firm’s approach to sustainability risk; level two drills down into ESG products and gives more granular detail.
Sophie Reguengo, Partner at Ogier, says there is no official guidance on the applicability of SFDR in the Channel Islands, but investment funds consider this regulation will apply to non-EU alternative investment fund managers that market their alternative investment funds into the EU.
Providers hoping to have a market in the EU will need to comply. For those still grappling with the requirements, Shaun Robert, Director at alternative fund manager PraxisIFM, suggests firms prioritise getting their ESG policies and documentation in order.
“Make sure that information is available on the website,” he says. “Prospectuses need to be clear and should cover how sustainable risks are included in investment decision-making processes. Firms also need to look at how they integrate sustainable risk into their internal policies.”
Part of the motivation for SFDR is to drive out the greenwashers, and Robert is confident that the requirements will achieve this goal. “Before SFDR, providers could claim to have a green fund and it was difficult to challenge them. Now, they must provide more detail in black and white, making it easier for investors to know what they are buying,” he says.
Channel Islands’ green commitment
In March 2021, Jersey Finance published its commitment to sustainable finance. While the document is new, the commitment isn’t; the island has long been developing a presence in the field of ESG investing.
The latest approach aligns with the UN’s Sustainable Development Goals (SDGs), and sets out the plan to establish Jersey as ‘the leading sustainable international finance centre in the markets it serves’ by 2030.
Charlotte Brambilla, Associate Director, Financial Services for the Government of Jersey, says: “We are pleased that we have completed the roadmap and we have all the agencies working together with a clear framework.”
To achieve this ambitious target, the impetus cannot just come from government and industry, she adds. It is a challenge for “everyone on the islands”. The four main areas of focus include:
• Building strong stakeholder partnerships – to give all sectors within the industry the tools to integrate sustainability within a joined-up policy framework
• Nurturing green finance on a green island – with greater collaboration between the finance industry, Jersey’s financial regulator the Jersey Financial Services Commission, the Government of Jersey and – crucially – the people of Jersey
• Improving perception and credibility – by measuring performance against independent frameworks to reinforce Jersey’s reputation as a good global actor
• Increasing capacity to upskill across the board – to prepare for and take advantage of the global trends in ESG and sustainable finance.
Guernsey Green Finance
Nearly two-thirds of asset managers operating out of Guernsey have seen an increase in interest for ESG strategies from clients in the past 12 months.
This was a central finding from an ESG survey published by Guernsey Finance last September and reinforces the need for the island to promote green investment through its Green Finance initiative.
The Guernsey Green Fund, which was established in 2018, is the world’s first such regulated product and boasted a total net asset value of £3.5bn at the end of 2020.
Andy Sloan, who chairs Guernsey Green Finance, says the island will continue to pursue the sustainable investing agenda this year. “We spent much of 2020 evangelising the sustainability agenda and we look forward to discussing the progress made and the work still to be done at our 2021 Sustainable Finance Week to be held in early June,” he says.