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Supplements » ESG Report May 2021

Roundtable: Understanding context to make sense of ESG data

Funds Europe – How have you been preparing for the EU’s Action Plan on Sustainable Finance and how big a headwind is Brexit and the UK’s decision to introduce its own taxonomy for sustainability – or is it additional competition in a race to the top?

Håkansson – Since last year, we have had an internal working group monitoring all the developments within the EU’s Sustainable Action Plan, it’s not just the SFDR that will impact us. Having said that, from our perspective, we are more interested in understanding how the Action Plan will indirectly impact us and the companies and investments we make, and of course the products we invest in, so that’s the main objective from our end in terms of understanding.

We have been in discussions with fund managers on the different aspects of SFDR reporting. It’s been quite interesting to follow the development and hear the differences within the EU on how to define and how to categorise Article 6, 8 and 9 funds. That varies from my perspective. Over time, the interpretation of the SFDR will gradually align, but initially there will most likely be some differences across the market on how to interpret the regulation and how the different products are defined.

Murphy – We’re helping our clients to understand the impact of the SFDR on their funds, how they’ve been categorising them and the reporting requirements. I’ve seen a majority of managers look to categorise within Article 6, so non-ESG funds, and I’ve been trying to understand and ask questions around why so many have opted for Article 6. It’s partly due to the split between Level 1 and Level 2 and people were concerned – although they had already integrated ESG into their portfolios – as to whether they would ultimately classify as Article 8 funds.

Despite this milestone on March 10, it’s a very ambitious piece of legislation and is ultimately a call to arms to the investment management community. It’s going to become more of a focus, particularly as the Level 2 requirements come into play next year and for reporting the year after.

From a Brexit perspective and the UK’s own taxonomy, we still need to learn a lot more about exactly what the government is planning to do. I personally don’t think it’s helpful to have multiple different taxonomies – it’s better to have standardisation and consensus which will ultimately help investors understand what those disclosures mean, so I would hope that there is significant alignment with the EU taxonomy as well as other governments as they look to bring this in in the US or Asia.

O’Hara – The UK government has been very focused on the TCFD, and Chancellor Rishi Sunak made announcements towards the end of last year about mandating that across the UK economy. The Department for Work and Pensions (DWP) have consulted on mandating it and we’ve had conversations with the Department for Housing, Communities and Local Government, which is the relevant department for our pool. So, our focus has been mostly on the TCFD and TCFD reporting as being the immediate challenge for us, and we feel like we’re in a comfortable place with that. We’ve also done a lot of work with our partner funds to help them assess climate risk, communicate their approach, put governance in place and comply with the TCFD.

Where this immediately is relevant for us is the conversations that we have with the large portfolio managers, the large asset managers around mandates. We’re looking for opportunities to invest in more sustainable strategies and sustainability-focused strategies. It’s hard when communicating with the pools and the beneficiaries about what they might look like and how we would define those and categorise those, and the separation between the different strategies. That’s been quite challenging but even UK-based asset managers will need to embrace the SFDR, particularly if they want to sell products in Europe. Their categorisation of their products is going to help to inform our understanding of what they are doing and trying to achieve, it’s going to help to inform the conversation we have with our beneficiaries and the pools.

In terms of us having to comply with it ourselves, with the UK government’s decision not to mandate it at this point in time, it’s not something that is of immediate concern to us, but certainly using it to inform and improve our communications around sustainable investing and sustainability is important. We do thorough due diligence on these funds before we invest, and refresh this on an ongoing basis through monitoring. It’s more of a language and communications point for us at this moment in time in terms of those discussions.

Shukla – The UK chose not to onshore the SFDR into some legislation, so strictly speaking, UK funds don’t have to do anything, but as we all know, fund management is a global industry, so I’d be very surprised if UK-based fund managers are not complying, because if you want to sell your product in the EU, you have to do it.

The Financial Conduct Authority (FCA) is due to consult on its own sustainable finance regime this year. As a UK final salary scheme, the focus has been on the TCFD and the government has been quite clear on what it expects the large schemes to do, and so in some ways our hands are full in terms of making sure that we are covering the climate change risk.

Even though we are not required to comply with the SFDR, there are some very clear impacts that are coming from that. Classifications like these are helpful in terms of our understanding of green products and strategies, which helps to improve our communication with our members and trustees. Despite not having to comply, it’s a very helpful thing to have.

Having said that, it would be helpful to have some degree of regulatory standardisation on this matter and hopefully they focus on principles as opposed to detailed rules as any decarbonisation path will be dynamic. So, the EU guidelines run over 192 pages – if you need that many pages to explain what sustainable investment is, then that can be challenging. That’s just the EU – we might have our own version in the UK, and that is before we even talk of what may come out of the US. What would be unhelpful is if we have a fragmentation of these different expectations from different jurisdictions. It may make everyone’s life difficult in terms of watching multiple actors and trying to understand what the common thread is. I hope there is a bit more connected thinking and implementation when it comes to the regulatory action, otherwise it would be a huge wasted opportunity for everyone to come up with their own version for something that is a global issue. There is a need for standardisation here and I hope the regulators are listening.

Bello – Taxonomy is the desired goal for most people, for most of our clients that we’re seeing and hearing from. The SFDR aims to harmonise standards and increase transparency for all investors and as the SFDR regulatory structure evolves, we’re going to see that further centralisation of definitions and concepts which is going to be crucial for the advancement of sustainable investing altogether.

We’re expecting the final disclosure rules to come out by the end of this year, and for large asset managers like BlackRock, anybody managing greater than £50 billion in AuM will have to abide by those rules by as soon as 2022, so the bar is quickly being set as per the UK Treasury’s interim report in November 2020.

Guirey – MSCI has clients across the entire ecosystem, so we’re trying to help facilitate both their and our own understanding of the requirements. From August 2020, we held a series of workshops that were attended by clients across the EMEA region and we provided one-on-one discussions looking at solutions and how the taxonomy could end up being translated into data and needs to facilitate the reporting around those aspects.

We did an online survey as well with over 900 clients participating, so we collated feedback from clients, and we created a landing page on sustainable finance on MSCI’s website.

There were some key highlights that came from this, particularly around the classifications and what Article 8 means – again, most people would consider that as funds integrating ESG considerations and being more focused on financial materiality – while Article 9 funds are seen as more focused on sustainability, impact, reduction of carbon emissions and more in line with the Paris Agreement. Definitions and how fund providers were interpreting the regulations and how they then might report on that is something that we worked extensively with our clients on from the summer of 2020 to date.

Funds Europe – Joe, you mentioned setting a bar, so if the SFDR implementation represents a starting point for ESG data disclosure, how important is it that funds go beyond collecting the mandatory data, given the scope of the requirements is likely to increase as the regulation develops, as well as the greater understanding of what is financially material?

Bello – In terms of what other reporting needs to happen, the data being collected now is only just proliferating and the question becomes: what do clients want to see reporting on and do they want to see it getting more siloed? Momentum for investing sustainably is now building, and the SFDR obligations that apply from today will be a key catalyst to accelerate this trend in Europe. As the SFDR regulatory structure evolves in the coming months, we see further standardisation of definitions and concepts as crucial for advancing sustainable investing.

Our 2021 Stewardship Engagement Priorities are mapped to specific United Nations Sustainable Development Goals (UN SDGs) given the significant intersection. We believe there’s value in identifying how a company’s business practices, products and services might contribute to certain UN SDGs as per our SFDR playbook.

Funds Europe – Do you sometimes have trouble defining those when it comes to issues that intersect, for example social justice and the environment?

Bello – It will come down to how you define and measure it. When it comes to the environment, this is a question we receive often in terms of the ultimate goals. Do you understand what your exposures look like in your portfolio? Can you evaluate the investment trade-offs? Can you stress-test the portfolio? The most important thing is reporting, so can you report back to your investors in terms of where you are on that trajectory and achieving those goals? The standards will ultimately depend on how you define them.

Shukla – On whether we need more data – there is already lots of data being collected, so my focus would be more on the quality as opposed to quantity. There’s data coming out from multiple providers, they’ve done a fabulous job in pushing the envelope forward.

The other area is the coverage of the data itself, because as we all know, the quality of data and even the quantity of data is definitely a lot better when it comes to the publicly quoted market, be it equities or bonds, but the private markets is a different story – we are barely scratching the surface there. Clearly, there is the ESG inability as more and more pension funds are holding non-public assets, it’s the holistic nature of our disclosures that matter to our members.

Finally, on data collection: clearly ESG and carbon are two very important lenses when it comes to our disclosures, but what also matters is the real impact our investments are having on the ground. For us, the 17 SDG goals are important in being able to convey the true impact our investments are delivering in a wider socio-economic framework – a really helpful metric for us when engaging with our members.