Laith Khalaf, head of investment analysis at AJ Bell, comments on the FCA’s new discussion paper on ESG disclosure, in which the regulator is considering the need for compulsory ESG labelling for investment funds to help investors in their decision-making process.
The Strategy will be built around five key themes:
Transparency: promoting transparency on climate change and wider sustainability along the value chain
Trust: building trust and integrity in ESG-labelled instruments, products and the supporting ecosystem
Tools: working with others to enhance industry capabilities and support firms’ management of climate-related and wider sustainability risks, opportunities and impacts
Transition: supporting the role of finance in delivering a market-led transition to a more sustainable economy
Team: developing strategies, organisational structures, resources and tools to support the integration of ESG into FCA activities
The FCA is also gathering feedback on supporting entity-level and product-level disclosures. The input received will then guide the FCA’s policy design in this area, ahead of consultations on new proposals in spring 2022.
Khalaf says: The FCA is taking on a massive challenge here, but one which will have big rewards for investors if it can crack the nut of making ESG investing simple. Greenwashing and confusion could seriously undermine the credibility of ESG funds and the investment industry more generally, so it’s imperative to address these issues.
The difficulty is that much of the underlying subject matter isn’t straightforward or objective. While net zero is an almost universal goal, the methods of getting there are not quite so unanimously agreed. Debate is still raging about whether nuclear power, blue hydrogen, and biomass are solutions to the climate crisis, or potential problems. The approach to ESG investing takes many forms too, with some funds simply tilting away from the worst ESG offenders, others entirely excluding them, and some funds actually seeking out companies having a positive impact on environmental and social issues.
Investors themselves may prioritise different ESG issues and take a hard or soft line on whether to invest in companies that are heading in the right direction, but not there yet. A successful labelling and disclosure plan will result in investors being able to pick funds that tick their own ethical boxes, without taking up too much of their time.
There have of late been some detractors of ESG investing who claim that it doesn’t make much difference to the climate change agenda and distracts from the responsibility of governments to tackle these issues. Undoubtedly the impact of ESG investing flows is more marginal than changing consumption habits. Not investing your pension in Shell doesn’t do as much to reduce emissions as not filling up your car with petrol. However, the likes of BP and Shell would not have been able to launch their net zero transition plans away from fossil fuels without the approval of the big shareholders who manage our pensions and investments. ESG investing might not be the whole solution, but it is part of it.
In the UK, there’s no doubting the strength of the sustainable investment tide, as last year responsible funds accounted for around a third of overall industry sales. This year looks set to be even bigger, and on current trends will eclipse 2020 to post a new record for ethical fund sales.
These funds still only make up around 5% of total assets, so there’s plenty of road ahead for ESG funds to eat the lunch of more traditional offerings. Perhaps that’s why almost all fund groups seem to be beefing up their sustainable investment credentials, even for funds which look to be stretching quite hard for the ESG tag.
The reality is that routine fund management practices can legitimately be characterised as ESG integration, they just never used to be called that. Even so, some of the resulting portfolios would likely leave sustainable investors scratching their heads as to why their money is being funnelled into oil companies and tobacco stocks. This reinforces the need for a clear disclosure and labelling system which avoids a mismatch between investor expectation and fund portfolio realities.
Today, we are in the foothills of the responsible investing evolution and it looks likely that ten years from now, ESG reporting will simply be part of the furniture. It’s going to take some serious donkeywork to get there, yet it could all be for nothing if communication with end investors isn’t improved. The funds industry already produces prospectuses and factsheets, in theory for consumer consumption, but they are difficult to find and generally unrewarding if you do unearth them, without a degree in jargon behind you.
The FCA’s plan to simplify ESG investing for consumers is a fantastic opportunity to get things right early doors, and who knows, perhaps even lead other fund disclosure documents into the twenty first century.
[Main image: marcell-viragh-ZQas4Ehf-F4-unsplash]
