Investment fund managers may succumb to exhaustion when confronting the tiresome array of frameworks, standards, and criteria to use if they want to align their operations and investments with accredited environmental, social, and governance principles.
They have little choice but to overcome their fatigue. As 2021 begins, choosing an ESG framework and developing a proper report on compliance are burning priorities. Covid-19 has focused greater scrutiny from society, investors, and regulators on companies’ social mandate as well as their environmental impact. The virus has made employee wellbeing a matter of companies’ moral responsibility as much as a source of operational resilience that can affect shareholder returns. It is critical for firms to articulate how their role in this global movement, and what it means for their business.
The global ESG ecosystem has seen numerous developments in the last year, most notably a drive toward standardization of frameworks. The intention behind standardization is to ease the burden of both fund managers and fund investors by providing a common basis on which to judge ESG programs. These efforts will gather steam in 2021, notably with the March implementation of the European Commission’s proposed framework, leading to greater adoption of ESG principles, and more transparent reporting.
In September, five framework and standard-setting bodies pledged to work toward harmonization of their respective systems[i]. They include CDP, the Climate Disclosure Standards Board, the Global Reporting Initiative, the International Integrated Reporting Council and the Sustainability Accounting Standards Board (SASB). These groups expressed a “shared vision” for creating a globally recognized set of materiality factors, and called on companies, regulators, and investors to provide feedback and contribute to the effort in the current year.
Also in September, the World Economic Forum, joining hands with Big Four auditors, published a white paper laying out a set of universal ESG metrics, and recommended disclosures for use in companies’ annual reports. The disclosures are designed to apply across industry sectors and countries, and cover qualitative actions, such as seeking advice about ethical and lawful conduct, and quantitative metrics, such as percentages to measure equality of pay for women and minority groups.
In November, eight Canadian pension funds that collectively represent $1.6 trillion in assets under management put their financial clout behind two ESG reporting frameworks[ii]. In an open letter, they said, “While we recognize companies face a myriad of disclosure frameworks and requests, it is vital that they report relevant ESG data in a standardized way,” and explicitly backed SASB and the Task Force on Climate-related Financial Disclosures (TCFD).
Fund managers would be wise to follow further efforts toward standardization in 2021. Convergence of the various frameworks will have implications for those just starting their ESG journey as well as those that have already embarked on it and may need to reorient their trajectory.
Sanne Group has found that LPs increasingly expect ESG disclosures on an ongoing basis rather than just during the pre-investment due diligence stage. Information covered in the due diligence questionnaires from the United Nations Principles for Responsible Investing or Institutional Limited Partners Association are now becoming commonplace in selected reporting templates. Sanne has seen a rise in the number of Asian fund managers engaging in ESG reporting in response to investor demand.
Regulatory pressure is mounting globally. The European Commission’s Sustainable Finance Disclosure Regulations (SFDR) takes effect on 10 March this year. SFDR was part of a package of legislative measures designed to set common rules for disclosures of financial products to include sustainability risks and other related information.
In the United States, companies are coming to grips with the Securities and Exchange Commission’s 2020 mandate for disclosures related to “human capital resources.” The disclosures, which could apply to private equity firms’ portfolio companies, cover factors such as employee training, employee turnover, health and safety metrics, and diversity metrics, among other factors.
In Asia, both Hong Kong and Singapore are taking the lead in promoting ESG as part of their economic growth and regulatory agendas. In Singapore, the central bank and Temasek, the government-owned investment company, are allocating billions to support sustainable finance and investments that generate a positive social and environmental impact.
In Hong Kong, the Securities and Exchange Commission will likely enact this year a framework informed by TCFD to require fund managers to report climate-related risks. It would make large managers responsible for a quantitative measure of “weighted average carbon intensity” at the fund level[iii].
Though standardization will ease the burden on fund managers, it does not alleviate it entirely. No framework is “plug and play.” Like accounting, fund managers must take a principles-based approach to identify and report material ESG factors, and clearly justify them in published ESG reports. Karlien De Bruin, Head of ESG at Sanne Group, says the WEF white paper is a good place for fund managers to begin given the blending of criteria, principles, and materiality factors from established frameworks.
Also, ESG takes years to implement fully. Fund managers must clearly outline their ultimate ESG goals and the timeline over which they will reach them as well as considerations and risk factors that may affect their success. And they must document their ESG performance over time and how that performance was obtained, e.g., through passively buying carbon offsets or actively reducing their carbon footprint.
Ultimately, fund investors will judge general partners ESG efforts on how well they justify their actions, the case they can make for their choices, and their ability to portray convincingly the journey they are on toward full compliance. Numbers matter, but offering them without context or merely adding more metrics will have diminishing returns when it comes to shaping perceptions of a firm’s ESG efforts.
Locking down this narrative part of ESG reporting – how a firm approaches social and environmental issues as part of its core business strategy – is crucial. Charges of so-called greenwashing are a real threat. LPs can see through weak commitments and half-hearted action. And activist groups that track climate and social issues will publicly call out companies that fail to live up to their purported ideals.
[ii] Alberta Investment Management Corporation, British Columbia Investment Management Corporation, Caisse de dépôt et placement du Québec, Healthcare of Ontario Pension Plan, Ontario Municipal Employees Retirement System, Ontario Teachers’ Pension Plan, Public Sector Pension Investment Board, and Canada Pension Plan Investment Board.