The 4 dimensions for real ESG players

The world’s resilience is being put to the test as the coronavirus pandemic continues to unfold, affecting millions of people around the globe. With large parts of Europe’s economy slowly recovering from lockdown, the European asset management industry is now bracing itself for what could be one of its toughest years since 2008.  

In this first article of a series focusing on sustainable finance, we present the four levers that Asset Managers can use to build trust and fulfill a key role in the transition to sustainable growth. In subsequent articles, we will explore the importance and implications of each lever in more detail and the challenges each encompasses.

Strong resemblance to climate change crisis

Despite early signs of the COVID-19 risks, the financial markets first remained relatively calm and cautious all the way to March 2020, before taking a sharp turn for the worst. According to Morningstar’s data, March saw investors pull out a staggering €250bn from European funds, making it the largest outflow in Europe’s financial history. Although the market has since witnessed rebounds in the following months, investors’ sentiment remains uncertain among rising fear of a second wave and global recession.

What we see from COVID-19 as it unfolds reveals three key characteristics about the pandemic: it disproportionately affects lower tranches of the social ladder; its impact can be felt across the globe and it calls for significant governmental intervention & international coordination. These characteristics show a strong resemblance to another crisis – climate change. While governments and corporates have already taken significant actions to manage and prevent the direct effects of COVID-19, it becomes increasingly clear that a lot more needs to be done to avoid pandemics and similar catastrophic events in the future.

Sustainable Development Goals

The World Economic Forum estimates a $2.5 trillion annual investment gap needs to be filled to achieve the targets established under the Sustainable Development Goals (SDG) framework by 2030. Given the magnitude of such investment, private finance actors are expected to support public efforts by guiding the investment flows to a more sustainable allocation of funds across Environmental, Societal & Governance (ESG) topics. As clearly stated in December 2019 by the European Commission in the European Green Deal, “the private sector will be key to financing the green transition”.

New routes to grow business

With low-cost investment products continuing to gain prominence among investors, the ever-present pressure on margins and traditional growth buckets flatlining, Asset Managers are increasingly looking for new routes to grow business. So, when investors, both retail and institutional, initially expressed a desire for greener financial products, the market followed suit with a whole host of sustainably marketed financial assets, rising to $30 trillion worldwide out of which $14 trillion were located in Europe in 2018. As green finance becomes more and more mainstream, investors and regulators alike are in turn increasingly sensitive to greenwashing practices where the commitments of investments in sustainable finance would be overstated. This sensitivity translates itself through increased regulatory scrutiny and the European Commission’s ambitious “Action Plan on Financing Sustainable Growth”. Interestingly, six out of 10 French investors now state that they consider an Asset Manager’s ESG capabilities as an important criterion in their selection process, a figure that is consistent across geographies & increasing over the years. In the European context, where half of the managed assets are considered as sustainable, Asset Managers can leverage the sustainable finance opportunity to create a more trusted relationship with investors & regulators alike.

Building a foundation of trust

Asset Managers willing to consider sustainable finance products as a core pillar of their future growth must adopt a new approach across the entire organization. However, successfully pivoting towards a sustainable and responsible business will require a foundation of trust that is achieved when four key levers are addressed. First, Asset Managers need to anchor sustainability at the core of their strategy through a sustainably centered and consistent company-wide strategy. Second, Asset Managers should pay close attention to the regulatory evolutions & gear up for unprecedented levels of transparency and controls related to their sustainable investments. Third, a comprehensive revision of their operations will allow Asset Managers to deliver on the promise of true sustainability. Finally, technology is and will continue to play a key role in pushing the frontier of sustainability.

1. Anchor sustainability at the heart of your strategy

This year marked the 50^th anniversary of the Davos forum, which saw many calls from heads-of-state towards CEOs to embrace ESG and place it at the forefront of their strategy.

Anchoring sustainability at the heart of the organization requires more than just words. According to Accenture and UN CEO Study’s 2019 research The Decade to Deliver: A Call to Business Action, 99% of CEOs across various industries recognize the importance of responsible business practices to their success, but only one in two is implementing it. The recent announcements of the largest asset management companies’ CEOs, on the other hand, leave little to no doubt on the fact that the industry is aware of the disruptive effect of sustainability, some seeing it as an upcoming “fundamental reshaping of finance”. With the majority of Baby Boomers, Generation X and Y investors increasingly worried about the purpose of their investments, leaders in the asset management industry will need to show that they practice what they preach by taking sustainability seriously. By doing this, they will build trust through their strategy, organization and people.

The profound changes in Millennials’ expectations in the workplace also call for a new talent strategy. This will ensure that Asset Managers can attract, retain and upskill younger generations in a context where profiles with a blended expertise in both ESG and financial acumen are currently in short supply. 29% of Asset Managers and Asset Owners are planning to hire new ESG talents from non-traditional backgrounds over the next 12 months.

With an increasingly crowded marketplace, Asset Managers will need to find ways to differentiate themselves. In 2019, a large study of 800 institutional investors in Europe and the United States shows that 60% of them consider ESG capabilities as “important” in their selection process. While this provides the perfect soil on which a purposeful-driven brand can thrive, we see less than one in five Asset Managers taking concrete actions to translate this into their branding.

2. Gear up for unprecedented transparency

With more than $14 trillion of European assets marketed as sustainable, the market has turned into a jungle of acronyms and jargon that can put off even the most seasoned investors. This signaled a need for a strong reaction from regulatory stakeholders willing to steer the financial markets towards more transparency.

Two reactions from regulatory institutions are currently emerging: on the one hand, an expansion of the label landscape and on the other, a new generation of financial regulations that aim at promoting transparency.

On the regulatory front, the European Commission released an “Action Plan on Financing Sustainable Growth”, followed more recently by a €1tn European Green Deal Investment Plan over the next decade. The measures included in the Action Plan are expected to provide the financial system with the necessary tools and framework to support its ambitious sustainable finance goals. These measures will indeed span from regulatory and commercial reporting requirements to integration of ESG matters, prudential measures for insurance and banks and the particularly noteworthy “Taxonomy of Sustainable Activities”, dubbed in 2020 as one of the most significant developments in sustainable finance and recently adopted by the European Parliament.

To deliver on the promise of unprecedented transparency in non-financial indicators, the Taxonomy establishes thresholds for sustainability across activities and requires a set of disclosure obligations for all products tagged as “Environmentally Green”. While the exact stringency of these thresholds is yet to be understood, it is safe to say that all Asset Managers will have to acquire a wide range of new data sets, covering all taxonomy compliant activities, retrofit their processes to handle these and prepare themselves to base their investment allocation decisions on such thresholds. In addition, they will need to develop the reporting capacities required to meet the transparency level expected by their clients and ultimately by the European Commission. 

These initiatives from the European Commission are a huge push towards a more transparent playing field. At the same time, they will pose real challenges for organizations to adapt in order to manage new data requirements. In Europe alone, 64% of institutional investors are planning to dedicate more resources to ESG as a result of these regulations.

3. Deliver on the promise of true sustainability

The renewed vigor and desire for transparency from the market and policymakers has created an environment where Asset Managers need to overhaul their operations to thrive. Even though more than 3000 investors pledged their signature to the Principles for Responsible Investments (PRI) and up to 78% of Asset Managers consider ESG as increasingly relevant to their strategy, a global ESG survey shows that only 26% are effectively confident in the integration of ESG capabilities across their operations. This suggests that Asset Managers are fully aware that they have room for improvement when it comes to delivering sustainability. And indeed, empowering investment professionals to approach ESG-driven investment decisions with the same rigor and accuracy as applied to financial metrics brings forth its own set of challenges.

First, in order to successfully embrace ESG-driven strategies, Asset Managers need to revise their investment operating model across all processes, governance and tools. Integrating ESG aspects throughout key intersections of the investment processes ranges from the inclusion of ESG factors in quantitative research reports to the implementation of ESG-driven investment risk metrics. Adopting the tools to reflect these changes throughout the investment process provides Asset Managers with the basis on which their investment professionals can make relevant decisions in line with the ESG investment mandates. Complementing this foundation with reporting lines fitting the ESG strategy creates an environment where such decisions can be taken consistently over time.

In parallel, Asset Managers should infuse sustainability into their data strategy to ensure that the same standards are applied to non-financial investment decisions as they are on financial ones. For many – if not all – taming the data was already a story on its own. Now comes the additional sustainable data layers. Research already shows that the market for ESG data is expected to grow into a billion-dollar industry by 2021, bringing with its rapid growth a wide range of complexity and granularity issues to which quick adaptability is required. With scalability in mind, managing this additional layer calls for a robust data governance model built on a strong IT and data foundation.

Ultimately, Asset Managers can capitalize on this new operating and data model to further reinforce their branding strategy towards a strong commitment to sustainability. By doing so and as already discussed in this first article of our series, Asset Managers can cultivate a more intimate relationship with their customers built on delivering the promise of true sustainability.

4. Push the frontier of sustainability

On top of an already disruptive digital movement in capital markets, demand for sustainable investment further fuels the need for data and above all the skills and tools to manipulate it. We think that Asset Managers supporting the new sustainable investment process in the following three ways will thrive in this new industry segment.

First, data processing technologies and artificial intelligence applications infused in the investment process will allow investors to process more data from many new sources. This has the potential to promote better performance and risk management.

Second, the asset management workforce needs to be empowered and trained to work with that data and the tools. Nailing the collaboration between human and machine will result in value creation.

Third and less obvious, the fast moving ESG evolution requires Asset Managers to be nimble and adapt their business quickly. This starts with having a technology stack that is up for the task. This can be achieved by partnering with the right companies to access technology services that enable them to lead the sustainable revolution.

A key role to play in the transition to sustainable growth

Asset Managers excelling in these four levers – anchoring sustainability at the heart of their strategy, gearing up for unprecedented level of transparency, delivering on its promise and pushing the frontier of sustainability – will reinforce their competitive position with the power to fully capitalize on the sustainable wave’s opportunities.  

In our next articles, we will focus on each of the four levers and their challenges in more detail, and how Asset Managers can overcome these challenges to play a key role in the transition towards sustainable growth.