Cayman Data Protection Law
1 August 2019
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Whether driven by ethics, a desire to attract investment or as a risk management tool, Environmental, Social and Governance (ESG) considerations are a hot topic in the private debt world and likely to become increasing important. A number of headlines have claimed how demand for ESG investment professionals has skyrocketed in recent years and there are many surveys that indicate ESG factors will play a greater role in investment selection in the years to come. EY stated that sustainable investment strategies have grown by 107.4% annually since 2012 and demand for such strategies is being driven, in part, by millennial's who prefer to invest in alignment with their personal values. Since millennial's are poised to receive more than US$30 trillion of inheritable wealth, sustainable investments will continue to grow in demand. The Legg Mason Global Investment Survey found that over 70% of millennial's would invest in sustainable funds over funds that don’t consider sustainability.
Starting with the environment, tackling climate change is arguably the biggest issue of our time and is obviously extremely high profile. Greta Thunberg might be leading the way but individuals, business as well as Government have a duty to make a positive difference. Bob Jackson, CIO of the New Mexico Educational Retirement Board stated that they would operate an ESG policy by inclusion rather than through prohibition of investments like fossil fuels, however, as public opinion strengthens perhaps the risk of association will reverse this position. A recent survey by Barclays of large fixed income managers found that only 18% of them rated the environment as the most important element of ESG, however, more than 50% of investors ranked the environment as their top consideration.
Al Gore famously stated, “Pollution should never be the price of prosperity” and it feels like investors are starting to agree. MP Mary Crelagh, Chairwoman of the Environmental Audit Committee advised that “It is encouraging that a majority of the UK’s largest pension funds say they are taking steps to manage the risks that climate change poses to
UK pension investments”.
The Social element of ESG is often mixed up with the environment, however, social considerations are an equally important factor in their own right. Infrastructure Investor reported how asset management giants Blackstone and Brookfield missed out on investment from the Chicago Teachers Pension Fund last year because of a deficit in workplace diversity. There are now numerous surveys and league tables ranking employers in terms of diversity and the best places to work and therefore it would not be surprising if this information was considered more closely for manager and intermediary selection in future.
Millennial's and the growth of sustainable investing
In order to attract and retain the best and brightest talent, it is no longer just about remuneration and benefits package. In a similar vein to the importance of sustainability in investment selection we are seeing greater importance placed upon an employer’s standing as a good corporate citizen when deciding where millennial's choose to build a career. Potential employees at interview are increasingly being asking how the company contributes to the local community and how staff can make a difference to society as part of their career. Initiatives like Mental Health Week have helped to raise the focus on employers’ responsibility towards their staffs’ well-being and flexible working hours, mental health champions and in-house mindfulness classes are becoming more and more common.
ESG takes root
Governance is probably the area that has been of most significance for fund administrators in relation to ESG. In recent years’ investors have undertaken increasingly detailed due diligence on their investments, investment managers and service providers. This has mainly focused on risk management, security, controls, business continuity and experience etc., however, in line with what has happened with investment managers I would expect the administrator Due Diligence Questionnaires to start to include areas on diversity, culture, environmental policy and sustainability. A BNP Paribas survey cited data (or lack thereof) as the biggest barrier to integrating ESG factors into their investment selection process. In future I expect corporate service providers to play a big role in overcoming this obstacle. There is a general acknowledgement across the industry that the quality of sustainability-related data is limited. The EU’s sustainable finance action plan includes considering issues for asset managers obtaining quality data.
Without a level playing field it is difficult for investors to make worthwhile comparisons between potential investments without standardisation on how ESG factors are measured and recorded. There is a danger of “green-washing” as entities look to exaggerate their ESG credentials. The difficulty essentially comes down to what should be included, how is it measured and how is it presented (sometimes ESG is integrated into the financial statements, included as a separate report or referred to an ESG policy on a company’s website) and all of these variables can change depending on investor or managers’ stance on the matter.
Positively, several groups have been looking for solutions, including non-regulatory bodies. For instance, the Task Force on Climate-related Financial Disclosures and the Sustainability Accounting Standards Board have developed qualitative and quantitative industry-specific disclosure standards, however, when it comes to the regulatory
approaches there is still a differing of opinion, especially when it comes to either side of the Atlantic. At the moment, in its most basic form, the US, ESG selection must be justified by explaining why it is necessary for an investment, while in Europe it must be explained why ESG factors are not considered.
The private equity world has been looking at ESG factors and reporting for longer than private debt, however, this is probably not an example of something that our younger industry can leverage off to catch up. Private equity managers could look at a company with poor ESG as an opportunity that they could turn around and add value in private debt, however this is unlikely given that our control over borrowers would be limited to provisions included in the loan documents, therefore we would be looking at ESG factors from very different angles.
Cost saving through outsourcing
There are also a potential extra costs to be considered as a result of ESMA’s technical advice to the Commission on amendments to the UCITS, AIFMD and MiFID 2 Level 2 frameworks. For example, whether managers will need to hire extra staff with specific ESG expertise, or purchase new technology, to ensure that sustainability risks and factors are effectively integrated into their systems and processes. By outsourcing these responsibilities to a service provider these costs can be managed and the expertise brought in to satisfy the requirements and provide additional comfort to investors that this is being provided independently.