Cliodhna Murphy, Executive Director, Product Development, gives her perspective and insights on ESG in 2021 and beyond in a recent piece featured in HFM Week.

The momentum for ESG has continued to gather pace, with 2021 seeing significant progress made in the areas of regulation globally, data collaboration and carbon consideration. Particular mention should be given to the advancements made at COP26, the formation of the Net Zero Asset Managers initiative, and the increase in sustainability linked loans. 

Data challenges and opportunities            

Over the past two years, significant progress has been made on the collection, standardization and reporting of ESG data, and this is continuing. One key driver has been the Sustainable Finance Disclosure Regulation (SFDR) Level 2 which stipulates prescriptive metrics that managers will now need to disclose. The industry, so far, has benefited from a reasonable abundance of relevant data, such as greenhouse gas (GHG) emissions, carbon footprint, carbon intensity, and board diversity. However, the industry is facing significant challenges around the collection of data for biodiversity, water emissions, hazardous waste and gender pay gap. 

In the public markets domain, many data vendors are focusing on enhancing their processes to collect this data, and managers will be able to partner with them to ensure the best coverage and accuracy for their portfolios. The introduction of the Corporate Sustainability Reporting Directive, which will also apply to EU companies, will further enhance the provision of data from those companies who are in scope.

In private markets, the collection of data needs to be carried out directly from the underlying companies and assets, managers can partner with platforms that can bring automation to this process.  Private companies are continuing to see a rise in investors requesting this information, and making this process as intuitive as possible helps generate better outcomes around data requests. 

Biodiversity stands out as a key area of concern and should be given significantly more focus taking into account the startling impacts and due to our heavy reliance on nature.

With the announcement of the European Commission’s extended delay in the application of the Regulatory Technical Standards from July 2022 to January 2023, industry participants have been granted more time to refine the quality of their reports and establish best effort protocols. It is worth noting that the European Supervisory Authorities expect the first principal adverse impacts statement to cover the period from 1 January 2022 to 31 December 2022 and thus it is likely many managers will need to retrospectively overlay the SFDR data to their portfolios.

One of the reasons to feel optimistic is the current unprecedented collaboration by industry bodies, asset managers, investors, and data vendors to find ways to solve the data challenges and aid the flow of capital to sustainable investments, once we have standardization. This is undoubtedly a game changer for investors.

SFDR – The move from Article 6 ‘Non-ESG Funds’ to Article 8 ‘Light Green Funds’

Since the SFDR level came into effect on 10 March 2021, we have seen a shift from Non-ESG Funds to Light Green Funds. This could be driven in large part by investors looking to Article 8 funds as the required standard and can be evidenced by reflecting on an Irish Funds Industry Association survey of law firms in the Irish market. The survey showed that at the time of the filing deadline, 5,159 funds were Non-ESG Funds (representing approximately 83% of all Ireland-domiciled Funds), 896 were Light Green Funds (representing approximately 15% of all Ireland-domiciled Funds),  and 127 were Dark Green Funds (representing approximately 2% of all Ireland-domiciled Funds).

In addition, MUFG Investor Services took a pulse survey at the (HFM) Private Markets Operational Leaders’ European Summit on 18^th October 2021 which also confirmed the significant shift from Non-ESG to Light Green Funds. Of the 52 participants in session, 17% were Non-ESG, 67% were Light Green, and 17% were Dark Green Funds.

Regulation in Asia and US becomes more prominent

It is clear that the EU is the most advanced and ambitious region with regard to their sustainable finance framework. However, we also saw positive momentum from the U.S., initially with the Securities and Exchange Commission (SEC) issuing a risk alert earlier this year, providing some guidance to managers on what constitutes ‘good’ and ‘bad’ ESG, as well as with the formation of the Climate and ESG Task Force. There is an expectation that the SEC will mandate more preceptive disclosures next year primarily focused on environmental metrics such as GHG emissions, financial impacts of climate change, and progress towards climate-related goals.

Singapore and Hong Kong are leading the way in Asia on regulations. On Aug 20^th, 2021, the Securities and Futures Commission issued ‘Consultation Conclusions on the Management and Disclosure of Climate-related Risks by Fund Managers’ and confirmed they will amend the Fund Manager Code of Conduct to require fund managers managing collective investment schemes to take climate-related risks into consideration in their investment and risk management processes, and make the appropriate disclosures.

Singapore has also been pioneering innovative projects to help solve some of the data challenges. In November, The Monetary Authority of Singapore announced Project Greenprint to harness innovation and technology in order to promote a green finance ecosystem by mobilizing capital, monitoring sustainability commitments, and measuring impact. 

Carbon footprint

The momentum around carbon has continued to accelerate and there has been significant progress in the race to reduce our carbon footprint globally. Two key initiatives to highlight are the Net Zero Asset Managers initiative which now has 220 signatories and $57 trillion in assets under management and which has committed to supporting the goal of net zero greenhouse gas emissions by 2050, and the progress made during COP26.

One of the more prominent achievements of COP26 was the commitment by countries to “revisit and strengthen” their 2030 targets by the end of 2022 to align with the Paris agreement’s temperature goals, encouraging those who have not yet set targets to submit long-term strategies to 2050.

Fund Finance

The fund finance space is seeing a shift towards sustainability linked loans. Some of the key metrics that are being measured at the asset level are carbon (assigning goals around carbon net zero, carbon neutrality), and gender diversity These are measurable metrics and managers can truly influence their investments to improve outcomes. Metrics linked to the individual management companies’ performances are also important, where they hold themselves accountable for their governance, environmental impact, and social progress. In practice, term sheets outline the targets, and a margin ratchet is in place if these targets are achieved.

Summary

2021 in review, the global regulatory landscape has been evolving at a rapid pace, managers need to continue to focus on understanding their obligations in order to meet the demands and expectations of regulators and investors. COP26 provided a hugely important platform to reflect on the current challenges and make meaningful commitments. The finance industry has responded to the call to arms with the Net Zero Asset Managers initiative which gained significant traction this year. 

2022 will see a continued focus on the development and implementation of regulations globally which will drive further collaboration within the industry as well as drive the required standardization investors need to make meaningful decisions around capital allocation. To solve the data challenges will need to better leverage innovative technologies such as blockchain to develop a single source of truth that investors can rely on Although there is still much concern around the availability and quality of ESG data, we must reflect on how far we have progressed and be heartened by the collaboration that has lead to the improvements made, which we must continue to build upon the foundation now in place. A key focus area for future collaboration must be in the area of measuring our impact on biodiversity.

In the Fund Finance space, we will see sustainability linked loans will increasingly become the norm as well as other areas of financing.