2: Creating a climate risk framework

Climate risk awareness may be rising but large gaps remain in how these risks should be measured, monitored and managed.

The funds industry has emerged as a critical player in the transition to net zero. The International Monetary Fund (IMF), citing its own ‘Global Financial Stability Report’, forecast that the transition to net zero over the next two to three decades will require $20 trillion in additional investment.

And the funds industry is a likely source of this capital. “The world’s $50 trillion investment fund industry, especially funds with a sustainability focus, can play an important role financing the transition to a greener economy and helping to avoid some of the most perilous effects of climate change,” concluded the IMF.

Europe has taken the lead when it comes to climate funds. According to Morningstar, Europe accounts for more than three-quarters of global assets within a climate-related mandate with a total asset value of $325 billion. And while China and the US, with $47 billion and $31 billion of assets respectively, have far fewer climate fund assets, both saw their assets double within the last year.

The growth of the sustainable funds market has caught the attention of regulators, keen to ensure that investors are not short-changed by the rapid rise in sustainable funds. In particular, regulators are concerned about the threat of greenwashing and the wide variation in methodology and the use of data that makes it difficult for investors to compare different ESG funds.

2021 saw the introduction of the EU’s Sustainable Finance Disclosure Regulation (SFDR). But firms also face requirements for MiFID II, the Insurance Distribution Directive and whatever rules the UK brings out. Added to this are other sustainability-related initiatives such as the Taskforce on Climate-Related Financial Disclosure (TCFD).

There is also a growing recognition that ESG factors, and climate change especially, represent a significant investment risk. In the 2021 Funds Europe/CACEIS survey, the ‘green transition’ was cited by 30% of respondents as the greatest risk facing the funds industry over the next three years.

ESG_standardsBut how are firms treating this risk? Are fund boards meeting their fiduciary duty by tracking the investment risk posed by climate and other ESG factors? Do they have access to the required data? Are they able to interpret that data and have they implemented a workable reporting framework that tracks ESG and climate exposure at a granular level?

Against this backdrop, the survey asked how important ESG standards will become in fund governance (Q1). It found that 70% believe they will become or are already mandatory. This is slightly down on the 73% that answered the same question in the same way in the 2021 Funds Europe/CACEIS survey. However, the difference is that more people now feel that ESG standards are already mandatory (31% as opposed to 22%).

Climate_change_risk_standardsThis signifies the scale of the challenge facing the industry and the inevitability of mandatory reporting.

The survey also asked how important climate change risk standards will become in fund governance (Q2) and found that a similar number believe they will become or are already mandatory, 45% and 18% respectively. Just 10% do not believe they will have a major impact or else see them as a “just another guideline”. This finding supports both the idea that ESG standards are going to be mandatory measures and that climate change is likely to become a standalone issue in its own right.

In terms of the progress of asset managers’ net zero commitments (Q3), almost half (48%) are focused on implementing their commitments while over a third (35%) are planning to do so.

zero_commitmentsThere have been lots of public statements from asset managers in reference to their net zero commitments. The Net Zero Asset Managers (NZAM) initiative launched in December 2020 with the mission statement to “galvanise the asset management industry to commit to a goal of net zero emissions”. As of the end of 2021, it had 236 signatories with a combined £57.5 trillion in assets under management (AuM).

However, signing up to a commitment is one thing and implementing those initiatives is another. And the survey shows that we are still behind where we need to be as an industry, with less than half (48%) saying they have implemented their commitments.

Read the full report

1. Survey highlights

2: Creating a climate risk framework

3: Importance of investment risk overlooked

4: Internal governance still developing

5: Education and skills are key

6: Data availability challenge misplaced

7: Reporting issues

8: Product development

9: Engagement vs divestment

10: Recommendations and regulation

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