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Magazine Issues » October 2019

Association column: ESG regulation

Will_GoodhartRecent history tells us that it is important for investors to have a clear understanding of the way a fund is invested and the risks involved. As yet, we are not able to do that in relation to ESG investing, though we are making progress.

The good news is that incorporating environmental, social and governance factors into investment processes is unlikely to expose investors to unexpected risks (other than to the upside), but too little is being done to allow investors to understand where investment managers are incorporating ESG factors into their investment process and with what degrees of intensity.

Today, a UK equity fund that incorporates a third-party score on governance into its analytical framework can be described as an ESG fund just as easily as one that operates a positive screen based on detailed stewardship and analysis. The absence of a standard that permits clear differentiation is allowing the whole market to lay claim to a positive marketing mantra, though only some firms are likely to be living up to the expectations that investors have. In the market’s defence, those expectations themselves are still ill-defined.

As the public’s interest in sustainability and battling climate change continues to grow, ESG is becoming increasingly popular in investment. We need to move quickly to develop standards that recognise different sets of expectations and define minimal criteria for how those should be met. Many groups across the EU have already set different standards. In the UK, the FCA has noted its interest in this issue and the Investment Association is working on its own framework.

To allow the global investment market to work effectively, we need to make sure that there are standard requirements around labels for ESG and that these are useful to consumers. Investment firms should be given the freedom to hone their own approaches to ESG, while ensuring a standard level of competency and accountability. This will be easier said than done, but at EU level, positive steps have been taken to set out a framework for deciding what can and cannot be labelled as ‘green’.

The taxonomy launched by the European Commission’s Technical Expert Group on sustainable finance in June can be used to establish the relative ‘greenness’ of funds based on their contribution to one of the six EU environmental objectives.

Beyond regulation, there is also a job to be done in upskilling the investment profession. At CFA UK, we are focusing our efforts on improving education for investment professionals on ESG. We recently launched the Certificate in ESG Investing to equip investment professionals with the benchmark knowledge and skills needed to integrate ESG factors into the investment process. Our global network, CFA Institute, is also working on the development of an ESG standard. These steps will ultimately help guarantee a standardised level of competence and give consumers confidence that the ESG funds they invest in do what they say on the tin.

Standardised regulation and self-regulation can go a long way towards solving the issues around ESG investment. However, it remains important that they harness the power of the market, rather than trying to replace market functions; regulators are here not to run the market, but to make sure it works well. Once the appropriate regulatory frameworks and taxonomies are in place, investors will be able to access and understand the information needed to make their own decisions.

By Will Goodhart, chief executive of the CFA Society of the UK

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