Asset managers face higher operational and compliance costs in the coming years as new environmental, social and governance regulations weigh on profits.
That’s the warning from credit ratings agency Moody’s, whose analysts warned that last month’s sustainable finance proposal from the European Commission, was likely to impact fund firm profitability, calling it “a credit negative”.
In a report, associate analyst Simon Hennige, suggested that the EC proposals are likely to be enacted before the European Parliamentary elections in 2019 and will mean asset managers will have to invest.
He said: “Asset managers will need greater ESG expertise to do so going forward, incurring costs from the specialists, the data and analytics of ESG investing. Sustainability is not binary by nature and its criteria are mostly qualitative, making it complex and costly to track, analyse and report.
“Moreover, finding consistent, high-quality data to guide ESG investing is a particular challenge given a lack of universally accepted ESG definitions and standard reporting guidelines.”
Hennige added that the burden on asset managers will go further than costs, because of the new requirements to comprehensively explain how they consider ESG factors. As a result, they will need to update their product suite and prospectuses accordingly, he said.
ESGClarity.com approached three investment groups named in the Moody’s report: Legal & General, Aviva and Standard Life Aberdeen.
Responding to enquiries, Aberdeen Standard, the investment brand of Standard Life Aberdeen Group, said that while there was a cost of integrating ESG factors into investment processes, the largest players in the industry would be able to absorb this.
Campbell Fleming, global head of distribution at Aberdeen Standard Investments, said: “There are costs involved and they may rise, but the size and scale of Standard Life Aberdeen means they can be absorbed and we also have the financial strength to invest more into ESG.
“Long-term I anticipate an increasing amount of the flows to be channelled into strategies that incorporate ESG. ESG is embedded in our investment capabilities from equities, fixed income through to multi-asset and private markets to help meet the needs of our clients.”
Aviva Investors’ chief responsible investment officer, Steve Waygood, said the EC Action Plan was welcome, saying it would give investors greater insight into fund manager practices.
“While most fund managers across the EU claim to integrate ESG issues into their investment analysis and AGM voting, very few of us are good at disclosing how this has actually happened in practice,” he said.
“This doesn’t help those clients who care about these issues make better investment decisions. Taken as a whole, these proposals should lead to longer term investment decision making, more support for long term investment by companies, more transparency by fund managers and better outcomes for individual investors across the EU.”
However, investment intermediaries were quick to caution asset managers that any additional costs loaded into products would need to be justified, adding that much more justification was required of the cost benefits of some claims attributed to certain ESG approaches.
In a written statement provided to ESGClarity.com, Patrick Connolly, head of communications for financial advisory group Chase de Vere, said with increasing numbers of fund firms purporting to integrate ESG into their processes, there needed to be clearer explanations of techniques and investor benefits.
He said: “A growing number of investment companies are keen to be associated with ESG credentials in the hope that this can create a positive perception of their business, increase investment assets under management and, hopefully, to do the right thing socially and environmentally.
“However, these firms cannot just pay lip service to ESG and still hope to benefit. They must be prepared to commit time, money and resources to establish credibility. As a result, they must understand that there are likely to be associated costs.”
Connolly added that if these companies do decide to pass extra costs to investors, they need to do so in a transparent fashion.
“This is fine on the basis that it is clear and transparent, and investors can then make informed decisions about whether they want to support ESG investments and are willing to pay an extra price for doing so,” he said.