Greenwashing is a nascent regulatory risk incurred by global investment organisations as investor demand for sustainable products increases exponentially. Investors are also requesting accreted environmental data disclosures, demonstrated by the amount of global investors requiring corporate environmental disclosure growing by 56%1.
Morningstar reported assets in funds comprising sustainable objectives or promoting environmental or social attributes aggregated €4.05 trillion at the end of Q4 20212 and represented 42.2% of all funds sold within the EU.
Greenwashing is referred to by the UK government as “misleading or unsubstantiated claims about environmental performance” asserted by investment firms regarding their products or activities.
During 2021 inflows into Environmental, Social and Governance (ESG) funds compounded and surpassed total inflows of $51.1 billion in 2020 before the end of Q33. When 2021 concluded, Asset Managers whose combined AUM amounted to over $120 trillion signed an agreement to incorporate ESG data within their investment mandates4.
Bloomberg estimated ESG AUM could constitute over a third of the projected $140.5 trillion global total by 20255 and reach $53 trillion; an increase of $37.8 trillion by year-end.
Regulators are concerned Asset Managers may overstate the positive attributes of sustainable products due to pressure to retain a competitive advantage within a growing and profitable market.
Are Your Funds ESG Box-Ticked?
Investment firms must obviate utilising vague boilerplate data disclaimers, which regulators and other stakeholders view as a “tick-box” method.
Asset Managers are required by Sustainable Finance Disclosures Regulation (SFDR) to disclose data limitations in pre-contractual documentation for Article 8 and 9 funds. The FCA’s SDR DP proposes disclosure of granular product level information on data limitations and methodologies.
Investment organisations should specify data limitations in their pre-contractual disclosures and outline implications for end-investors.
Asset Managers must address disclosure requirements and a devoid standardised definition of a product’s sustainability to capitalise on the unprecedented proliferation of sustainable investments.
The redundant standardised ESG reporting framework was reflected in KPMG International’s 2020 Sustainable Investing report6. The report illustrated a lack of consistent ESG data and ambiguous terminology were Hedge Funds’ primary barriers to ESG implementation.
Have You Incorporated Sustainability Within Your Fund Strategies and Documentation?
The majority of ESG data is reported autonomously by asset managers or is proxy and unverified or audited by an unregulated ESG ratings industry, which causes limited materiality, accuracy, and reliability.
The FCA addressed these issues when conducting a consultation7 that encouraged ESG data and rating providers to adopt a voluntary Best Practice Code. The FCA additionally advised the Treasury to integrate ESG data and rating providers’ activities within the FCA’s regulatory perimeter.
Primary Regulatory Initiatives to Consider
ESG and sustainability are growing to constitute a large proportion of global investment strategies which observe multiple regulatory initiatives.
Asset Managers currently employ disparate investment strategies for sustainable investing, such as exclusions/negative screening, best-in-class investing, thematic investing and impact investing.
Negative screening strategies can completely exclude particular sectors and equities and solely authorise investment in companies comprising postulated amounts of revenue derived from unsustainable activities.
Portfolio managers should clarify if an exclusion or inclusion is fortified by proprietary organisational activities or if it includes further entities the supply chain or with partners to prevent greenwashing claims by end-investors.
COP26 highlighted the re-allocation of capital toward sustainable activities and the Taskforce on Climate-related Financial Disclosures’ (TCFD) recommendations8 became mandatory at the summit.
The mandatory TCFD disclosures application for premium listed issuers and Asset Managers by the FCA will develop the availability of new data. The disclosures were effectuated 1 January 2022 and apply to Asset Managers with over £50bnn AUM that must initially report by 30 June 2023.
Asset Managers with AUM between £50bn and £5bn are subsequently subject to the rules after 1 January 2023 and must report by 30 June 2024.
The EU are also enacting the Corporate Sustainability Reporting Directive (CSRD) that extends the Non-Financial Reporting Directive (NFRD) to listed organisations on regulated markets and large non-listed companies and requires more exhaustive sustainability disclosures.
The FCA’s ‘Dear AFM Chair’ letter issued in July 20219 established guiding principles for sustainable funds managers. The guidelines attempt to advise Authorised Fund Managers (AFMs) to comply with existing requirements and ensure fund disclosures accurately reflect the fund’s responsible or sustainable investment strategy to abate greenwashing concerns.
The International Sustainability Reporting Standards (ISRS) have also been developed to standardise sustainability disclosures. The ISRS aim to systematically improve underlying ESG data available to the market and support increased ESG ratings products consistency and validity.
The FCA issued a discussion paper composed of proposals for new domestic Sustainability Disclosures Requirements10 during November 2021. The proposals suggest a multiple disclosures framework including product level disclosure and data limitation product and investment firm disclosures. The framework also incorporates a five-pronged labelling regime for all investment products using standardised terminology to deter greenwashing.
The European Securities and Markets Authority (ESMA) additionally published a Sustainable Finance Roadmap 2022-2024 that prioritises tackling greenwashing and the International Organization for Securities Commissions (IOSCO) established regulatory and supervisory expectations to reduce greenwashing risks.
Futureproof by Re-Engineering Your Data Architecture
Investment organisations can build ESG reporting transparency by leveraging data analytics to enhance their collection and aggregation of proprietary data.
Deploying a normalised enterprise ESG taxonomy supported by a centralised data repository increases auditability and enables real-time adoption of new data standards and controls within your technology architecture.
Partnering with a software development third party enables you to efficiently assess over 500 ESG data fields from sustainability data providers using a structured, formal and verified approach. A software partner can help you close ESG ratings gaps and improve your ESG risk profile and concurrently mitigate technical debt and legacy software risks.
Synetec can help you develop your pre-contractual dialogue with investors and ensure transparent investment strategies, top holdings, due diligence and data sources disclosures.
Build an ESG data edge with Synetec to monitor the emergence of new data from investee companies in the post-investment stage of an end-investor’s asset management journey.
References
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