Industry Comment

SPONSOREDUnderpinning the ESG transition: the role of outsourced investment compliance

ESG, transition, outsourced, investment compliance, regulation, institutional investors, requirement, SFDR, compliance, portfolio, Nevan Redmond, BNP ParibasAs ESG regulations ramp up and institutional investors grapple with the requirements of the SFDR, outsourced investment compliance can offer independent assurance and enhanced portfolio monitoring, writes Nevan Redmond, global head of product, depositary and fiduciary solutions, securities services, BNP Paribas.

The exponential growth of ESG and sustainable investing shows no sign of slowing down. Almost half the world’s assets under management are now committed to a net zero emissions target, with Bloomberg predicting this may surpass USD 53 trillion by 2025.

It is, however, not easy for firms to accurately assess the true ESG credentials of different funds – a process made harder by the inconsistency of ESG labelling practices.

Across Europe, individual Member States offer their own flavours, with EU funds able to choose from at least nine ESG-style labels. The criteria underlying the labels combine objective standards (usually in the form of sector exclusions or limitations) with subjective criteria, including ESG practices, internal controls and guidance on exercising voting rights. The use of these subjective criteria, which relies on individual asset managers’ interpretations, has led to some concern in the industry about the consistency of labelling.

SFDR: raising the bar

The SFDR, first introduced in March 2021, aims to bring consistency and comparability to the EU fund industry’s sustainability-related labelling and provide greater transparency on financial products’ sustainability.

Since then, asset managers and their clients have grappled with providing the appropriate entity-level disclosures to meet SFDR requirements. In particular, the definition of sustainable investment at the centre of Article 9 funds’ definition still proves to be extremely challenging. This lack of certainty and consistency as to the meaning of sustainable investment is one of the key drivers behind several asset managers’ reclassification of their ESG funds from Article 9 to Article 8.

Since January 2023, a new wave of “Level 2” requirements has been introduced, which includes a range of new reporting templates for ‘light green’ and ‘dark green’ funds. This significantly raises the bar for investment firms’ ESG scoring.

Fund classification and credentials

Nevan RedmondHow can asset managers prove that a product should be classified under Article 8 or 9 of the SFDR? While negative screening has been an established ESG methodology for many years, ESG scoring for disclosure purposes is in its infancy. This is where investment compliance monitoring solutions can help. An outsourced investment compliance solution can provide independent confirmation of the fund’s classification and credentials to the asset owner, regulators and investors.

This is why BNP Paribas has enhanced its existing investment compliance screening capabilities to include a wide range of ESG criteria. Whether a fund seeks to confirm adherence to SFDR or other ESG-related fund labels, our compliance solution can incorporate new rules to monitor the additional ESG criteria. For instance, carbon footprint metrics can be monitored at asset and portfolio level to ensure the fund meets its objectives as well as the monitoring of a portfolio’s alignment to the EU taxonomy. Rule cards can be developed to monitor the unique criteria applicable to labels and confirm a fund’s adherence to its benchmark.

Independent assurance

It is vital that the investment compliance rules which underpin ESG labels are appropriate and regularly monitored. Institutional investors need independent assurance to confirm that the criteria that support the labels are met, for example, sector exclusions and exclusion of companies involved in prohibited activities.

Many asset managers are developing their own ESG scoring based on huge amounts of raw data. Asset owners want to make sure asset managers will do what they say and may require much stricter controls in their ESG portfolios. By employing third-party, independent checks and data sources, they can make sure their ESG-related investment guidelines are strictly adhered to.

Independent third-party validation of non-financial processes, controls and data outputs can also help asset managers to build trust with investors. It can help them to differentiate their products from others whose products use in-house, or limited, screening processes.

Managing scale and complexity

As investor demand and regulatory scrutiny grow, institutional investors must apply increasingly sophisticated screening methodologies, provide relevant disclosures, and ensure adherence to the correct categorisation and labels.

However, many firms may not have in-house teams with the necessary expertise, technology or data. Screening and monitoring ESG criteria require look-through capabilities, data and the technical expertise to conduct portfolio, fund and company-level assessments. BNP Paribas’s Securities Services business can offer large teams of compliance and ESG specialists who can support clients with this.

Our solution processes data feeds from both external and internal sources in order to screen portfolios against customised and flexible criteria tailored to firms’ ESG framework. This could include standardised ESG ratings and benchmarks, exclusion from specific activities, inclusion or restrictions from specific sectors, countries or companies, and the impact of controversies. With access to such a broad range of criteria, institutional investors can fully explore their desired ESG methodologies or frameworks without being restricted by their in-house capabilities or resources.

Building the ESG compliance capabilities of the future

Investor interest in ESG funds is only set to grow. Increasingly, investment compliance providers are vital partners in helping the investment industry to build trust with investors and ensure ESG funds are constructed in accordance with regulations.

© 2023 funds europe

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