Here’s a question: how will ESG impact investment managers’ and fund administrators’ compliance responsibilities to investors, and the reporting services they provide in response?
Investment firms already assay clients’ risk appetite during onboarding. Extending the process to generate a personalised ESG profile for each investor – that sets out their preferred exposure for the different E, S and G components, and the types of investments they want in the portfolio – would seem a logical future step.
The performance of an investor’s portfolio and how it aligns with their ESG mandate would then need to be measured and reported back to the client. How, and how often? How granular would the initial ESG policy and subsequent reporting on the portfolio constituents likely be? Rather than just a periodic snapshot at the fund level, will investors expect a real-time, transparent look-through to their investment positions broken down by ESG factors based on their personal criteria?
What compliance implications would this have?
A multitude of funds are marketed as ESG today, but greenwashing is rife. The European Union’s Sustainable Finance Disclosure Regulation (SFDR) aims to promote transparency for investors trying to compare and understand the sustainability profile of funds. The Article 8 (“light green”) and Article 9 (“dark green”) product classifications are meant to help eliminate such greenwashing. Similar proposals in other jurisdictions are coming.
Yet reports suggest around 80% of Article 8 funds were invested in fossil fuel companies, while more than a fifth have a questionable ESG profile. Earlier this year, Morningstar analysis found more than 1,200 funds managing over $1 trillion weren’t delivering on their ESG goals and were stripped of the label.
Rather than trusting to funds’ labels or companies’ statements, managers may need to conduct more deep dive analysis if they are to create a portfolio that aligns with an investor’s ESG profile. Once constructed, they would need to monitor and adjust the portfolio investments to ensure each remains compliant on an ongoing basis with what the investor signed up for.
And where will the onus lie? Is it up to the investor to read the managers’ reports and conduct research to determine whether they want to allocate to an investment initially, and to check that the funds invested in continue to comply with what they said they would do? Might the fund administrator have to conduct that compliance with the investor’s ESG profile on the client’s behalf? Should there be transparent reporting and compliance breach mechanisms to alert the investor when a company or asset in their portfolio no longer complies with the original offering?
The challenge of delivering investor-level ESG
The compliance challenge will depend to some extent on the degree of personalisation and granularity offered. Investor choice may be limited to a certain rating of fund. If the investment no longer met that rating, the investor could be switched out of the fund to a different one. Alternatively, an investor’s profile could be based on more in-depth ESG themes, with a mandate focused on, for example, green energy, modern slavery exclusion or diversity and equality.
The test from a reporting perspective will be to provide detailed transparency at the investor level, rather than merely reporting a breakdown of the fund’s assets. Where an investor has allocations to multiple funds, for instance, the administrator may want to report on the different ESG attributes across those funds, so the investor can see how their money is broken down by a range of ESG measures.
A joined-up data model and integrated systems that can provide look-through from the shareholder record to the underlying portfolio will be key to tracking the portfolio components and delivering transparent, timely (real-time or daily) reports on an investor’s ESG attributes.
Technology solutions can help. But if this is the direction of travel, a whole new level of responsibility and service delivery could be heading the investment management community’s way.
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