There’s no doubt it has been something of a difficult time for ESG investing recently.
Market conditions, including rising interest rates and soaring inflation, added to burgeoning returns amongst commodity funds in light of the war in Ukraine are making returns from both Article 8 and 9 funds hard to come by.
Meanwhile, the escalating cost of living crisis is forcing many investors to think more carefully about the ‘cost’ of their principles when it comes to where they put their money.
Another issue that is also coming increasingly into play is a number of barriers that the industry is yet to address. These are preventing advisers and investors from capitalising further on the initial excitement around ESG that has been growing over the past few years and exploded during the pandemic.
As Christoph Dreher, head of FE fundinfo’s ESG product group, points out, “interest in ESG investing is at an all-time high” so ways need to be found to capitalise on this.
The regulation barrier
Chief among these are the ambiguities that continue to exist, firstly around standards when it comes to defining what ‘ESG’ actually is and also sourcing relevant and impactful data that investors can understand and apply to their portfolios.
This is being keenly felt among financial advisers who are struggling to match their clients’ ambitions and preferences with the information that the industry makes available.
Policymakers have made some strides in recent years to tackle some of these issues. Our forthcoming white paper on ESG investing, Looking to the future: the growth and evolution of ESG Investing, looks at some of the regulations and standards that have been adopted and the progress made since 2020.
These include the Sustainable Finance Disclosure Regulation (SFDR), the EU Taxonomy and the recommendations form the Task Force on Climate-Related Financial Disclosures (TCFD), to name but a few.
However, research from our 2022 Financial Adviser Survey suggests that a lack of a clear set of standards and fears of greenwashing remain two of the top three barriers preventing them from promoting ESG effectively to their clients.
The data barrier
Data is another issue and in a recent feedback statement, the Financial Conduct Authority (FCA) acknowledged that ESG data and ratings providers are offering the market very different things.
In an increasingly crowded marketplace, a number of different providers have sprung up using their own qualitative and quantitative methods and, unsurprisingly, providing very different results.
According to that feedback statement, there are around 30 “significant” ESG rating and data providers, with the top three accounting for 60% of the market.
It’s no surprise, then, that the FCA said they will be taking a closer look at the services they deliver with a view to providing regulatory oversight.
This is having an impact again on the work of financial advisers.
When asked what their main source of ESG information was in our Financial Adviser Survey, just under half (49%) of advisers said they used multiple third-party sources, 21% used information provided by fund groups, 15% use quantitative ESG ratings, while 9% use qualitative ESG ratings.
On the surface, this is positive. Advisers are conducting their own research and using multiple information sources, but read another way, perhaps the bigger story is advisers are having to go to numerous sources to cover all the bases and find the information they need.
In such a fast-moving industry, where regulations and their requirements are constantly changing it is of course understandable that there is a gap between the information fund managers are required to provide from a compliance point of view and information which advisers might find of value for their clients.
Adviser and client education
Providing greater education – alongside information – is also key to boosting the promotion of ESG investing.
While 42% of advisers believe more education needs to be provided to clients, 34% also acknowledged their own understanding needs to improve as well.
It’s clear the market needs to provide more education and information that is accessible and easy to understand.
It’s perhaps too early to say whether the FCA’s – and other global regulators’ – move into regulation of ESG ratings will help, but it is difficult to argue with what they are suggesting from an education standpoint.
While the FCA suggest “we do not consider the different judgements reached by ESG ratings and rating-like product providers inherently to be a source of harm,” they also see a ‘clear rationale for regulatory oversight.’
Providing further transparency, sound systems and controls, good conflicts of interest management and robust governance can only be good for advisers and their clients.
It’s important to remember – and for the industry to press home the point – that ESG ratings are not like credit ratings, which all assess the same thing – the likelihood of the company going bust in the next year – so that they can make an objective judgement of what the rating is telling them.
The 2022 Financial Adviser Survey was conducted in November and December 2021. It consisted of 60 questions and was completed by over 200 UK-based financial advisers.