Background

As we head into 2022, the ESG flight is really taking off. On the one hand, Europe’s fast-evolving regulatory landscape has made ESG an unavoidable topic for most investment fund managers. By requiring all financial market participants to disclose information regarding the integration of ESG factors into their investment processes, the Sustainable Finance Disclosure Regulation (SFDR) represents one of the most transformational regulatory developments in the history of Europe's investment landscape. On the other hand, PwC Luxembourg expects ESG mutual fund assets to rise to between EUR 5.4tn and EUR 7.6tn by 2025 – making up between 41% and 57% of total EU-domiciled mutual fund AuM, up from 15.1% in 2019. This is coupled with 75% of institutional investors stating that they intend to discontinue investing in non-ESG products.

This White Paper takes a closer look at the challenges and opportunities of this evolving landscape, the practical implications, as well as the latest developments the fields of regulation and ESG data management.

The Current State of the Industry

Speaking at a recent webinar hosted by ONE group solutions, Michael Maldener (CEO of Sustaide / Acting General Manager of LuxFLAG), Johannes Höring (Partner at SIBEM Capital Partners), James Spanjaard (Co-founder of alis_) and Jan De Spiegeleer (Co-Founder of RiskConcile) joined Revel Wood and Tobias Ettlin (partners at ONE) to examine key ESG industry topics as we embark on 2022.

The general level of industry preparedness is quite diverse. Mr Maldener commented on the fact that many larger market players in the asset management space (especially in the Nordics) have been focussing on sustainable investing for many years and have been building a track record on this theme. They have identified the data sources they need and built a governance framework around ESG. But for many smaller players just now entering the ESG space, the challenge of locating, centralising and retaining relevant data in their value chain is a challenge, on top of regulatory costs and pressures.

Sustainable investing is not just a question of regulatory classification, however. The credibility and ethos behind these types of investment products is as important. Mr Maldener stressed that it all starts with a firm’s culture, that ESG has to be embraced throughout the entire value chain.

Data Challenges and Opportunities

It’s common theme in the market that, especially in the alternative space, there is a lack of ESG-related data. Mr De Spiegeleer made the point that, in a year from now, asset managers may be faced with the challenge of too much data. The European ESG Template which is being developed by the FinDatEx working group in consultation with industry bodies and is expected to be released in draft form in May 2022 will help standardise this data. The opportunity will lie in developing graphical ESG databases to reorganise the data and extract supply chain information down the chain. This requires new IA solutions. In the private space, data will have to be collected in direct relationships with the target investments using the parameters of the Taxonomy Regulation. Mr Spanjaard added that IA will become instrumental when it comes to manage ESG data beyond the human scale and integrate it into the investment process. Mr Spanjaard identified three main data stakeholders in this process: 1) governance, 2) marketing, and 3) portfolio managers.

Taxonomy and Data Standardisation

Mr Maldener identified the importance of the Taxonomy Regulation as a rulebook to follow, and recommended that asset managers should not use the unavailability of pertinent data as an excuse to fall short on evidenced ESG results.

Mr Höring quoted a recent survey performed among Luxembourg investment fund managers which stated that over 25% of surveyed managers have two or more ESG data providers, and 15% have more than four. Without technology solutions, it will be impossible to manage the data from multiple sources and convert it into the formats required for regulatory, risk and client disclosures.

The focus of the EU taxonomy for the moment is climate, with other factors (such as social and governance factors) to follow later on. Mr Maldener stressed that defining the right KPIs are crucial in determining the taxonomy alignment of each investment.

Distribution and Governance

“What are the needs of my distribution partners?” is a key question to ask yourself, according to Mr Maldener. This requires a shift of focus for asset managers from internal (investment management and compliance) to external (what data is relevant to my distributors). But your distributors are also a key source of information in terms of what the market is looking for.

Board of Directors face their own challenges. Many directors are getting nervous about promises and affirmations made regarding the sustainability and alignment of products they are responsible for. Mr Höring advocated for more ESG expertise, engagement and challenge on boards and a clear oversight and governance structure on the investment strategy, distribution and reporting.

Crucially, board decisions can only be as good as the information available to them. Mr Spanjaard warned of a pattern where marketing and investment management departments lead the way on ESG, with the board of directors being largely left in the dark.

Greenwashing (asset managers mis-representing the sustainability-related features of their products) continues to be a focus of regulators. Asset managers need to ensure an adequate control framework to mitigate this risk and protect investors, including appropriate policies and procedures, product disclosures, internal supervision and enforcement, as well as continuous training of staff.

It all comes down to data. Not just data sourcing, but also ensuring the relevant data reaches the right audience in the right format. The pilots in the ESG cockpit will depend on that data to ensure a smooth flight.