FT Adviser Podcast - Regulatory changes see ESG go mainstream

31 July 2020
Listen to our latest collaborative podcast with FT Adviser.

Ryan Medlock, Senior Investment Development and technical manager joins David Thorpe, Special Project Editor at FT Adviser and Steve Kenny, Commercial Director at consultancy Square Mile to discuss how changes introduced in recent years are placing environmental, social and governance (ESG) funds at the centre of the advice process and how these changes will help keep sustainable investing front of mind for advisers.

David Thorpe:               

Hello and welcome to the FTAdviser, four part podcast series on ESG Investing brought to by Royal London.

This episode of the podcast looks at how regulatory changes may affect adviser demand for responsible and sustainable investment funds in the future. I’m David Thorpe, Special Projects Editor at FTAdviser.

To examine the regulatory environment and its impact on the responsible investment universe, I am joined today by Ryan Medlock, Senior Investment Development and Technical Manager at Royal London, and Steve Kenny, Commercial Director at Square Mile Research. Thank you both for joining me today.

Ryan Medlock:        

Thank you.

Steve Kenny:          

Thank you.

David Thorpe:               

Okay, Ryan, how have regulatory changes impacted the responsible investing universe in recent years?

Ryan Medlock:        

Well I think the first point to make is that there has been an absolute raft of regulations proposed over the last couple years. I mean if you think about 2018 as a year alone, I think it was actually something like over 170 ESG-related regulatory measures proposed globally, and I think that sort of signals the scale of change in this particular area. A lot of these regulations are coming out at an EU level, and I think there’s some really, really good proposals coming out at the EU level and I think it's certainly leaving a lot of markets like the US and Australia are playing catch-up when it comes responsible investment.

Central to the EU’s plan is this Sustainable Finance Action Plan, and there’s a number of recommendations within that Action Plan; the taxonomy, so the EU-wide taxonomy being the number one recommendation. That’s a classification system for economic activities that meet environmental objectives, and I think that is going to massively improve disclosure and transparency, and also combat greenwashing to an extent. I might come back to the taxonomy later.

But another of the recommendations from that Finance Action Plan is the disclosure of regulations; I think they’re going to be very important. Obviously increased disclosure will invariably lead to scoring ESG funds and that opens up certain challenges. For example it’s much easier to score funds which are negatively screening, sectors or companies, as opposed to scoring funds which actively engage. So there’s some considerations there.

But back to the big regulatory drivers; obviously we know sustainability risk is to be integrated into a number of regulatory directives. The MiFID II amendment being one of those – obviously that is the big one, as far as advisers are concerned and this proposed amendment to Article 25 around the suitability assessment. I think that as a regulatory driver is really going to bring ESG investing into the heart of the financial advice process.

Closer to home, obviously we know there’s been a number of changes in the UK over the last six months or so; we had the new rules from the DWP – [they were in that] trustees of Occupational Pension Schemes around updating statements and investment principles. We’ve had new rules come out from the FCA in April, so they were in that Independent Governance Committees and IGCs now have to report on their firm’s ESG policies.

For me I think it’s really, really interesting that both law and regulation now accept that ESG factors are financially material to future returns. I think this has somewhat triggered a bit of a shift in mind-set over the last couple of years.

David Thorpe:               

Thank you. Steve, we’ve also had, at the adviser level, some regulatory changes around advisers’ suitability assessments and the conversation that they have with that end client and where ESG fits into that. Is how an adviser’s views ESG’s changing as a result of those requirements?

Steve Kenny:          

The adviser level is now starting to get to grips with what ESG is. I still think the vast majority of advisers have a high degree of confusion about ESG. I don’t think the market per se, in terms of the asset management community, is helping that. Because people still use ESG along with the other jargon in the industry in almost like interchangeable verbs, and they are very distinct in terms of what they mean and how they should be interpreted.

So I think definitely the interactions we’ve had with IFAs where ESG is very much part of their focus at the moment, and what they’re wrestling with is how do they bring it into their investment process? But the other thing that there is also a degree of concern from their part, because they’re not really comfortable with what it is, and therefore there’s a sort of reticence to start talking to clients about a subject matter that they themselves aren’t really comfortable with, for fear that they either mislead or misguide the client in this area.

So in answer to your question, it is definitely becoming more and more front of mind, but there is just a degree of concern at the IFA level because they need to get a better understanding of what it means and how it will play out in terms of investment.

David Thorpe:            

Thank you. Steve, do you feel that the obligations on an adviser from the regulators are likely to change in the years to come in this area around topics such as suitability, for example?

Steve Kenny:          

I think the fact that they’re going to have to build it into their advice process is going to necessitate them having that discussion. But that comes back to my first point; they need to get comfortable with what this means and how to engage with a client on the subject matters to actually have a proper conversation. One of the reasons I think that responsible investing hasn’t been as popular as it should be, in all honesty, is by a reticence of the adviser community to discuss it. I think it hasn’t been necessitated up until recently with the forthcoming regulation.

There’s been that classic view from the adviser that going down this route brings with it a headwind of performance. What we’ve seen in recent times is, in all honesty, going down this route actually ends up producing a tailwind in terms of performance. So some of the old urban myths that have surrounded this area in the market have started to dispel. But again I think there is a real challenge for us all to go on a sort of education promotion about this subject matter to enable advisers to feel comfortable with clients. Then I think that the great opportunity that we all believe is there will really come to fruition in this space.

David Thorpe:           

Thank you. Ryan, from your point of view and as a provider in the market, how do you think the regulatory outlook will change in years to come, and what that would mean for responsible investment products?

Ryan Medlock:        

Well I think the proposals and changes that we’ve had so far, I think highlight a very clear signal of intention and I think what we’re seeing from both regulators and policy makers is using ESG investing, and responsible investing in general, to re-inject a long-term focus back into investment activity. But that can only be a good thing, from my perspective.

You’ve obviously got massive ESG megatrends, the likes of climate change and whatnot, but they’re not going to disappear overnight. So it’s unlikely that the regulatory outlook that we have now is going to change. I think it’s certainly the case that we are likely to see more regulations being introduced in the coming years and we’re going to see wider adoption of different responsible investment techniques and approaches.

David Thorpe:                  

Thank you. But Ryan, are you worried that with the economic situation now, now tougher and a great deal of uncertainty in the world, that policy makers may push those responsible investment priorities further down their to-do list. And that companies out there in the market place who, in recent years have embraced this space at least somewhat or at least notionally, may discover that they’ve got other priorities in the deep recession.

Ryan Medlock:        

First and foremost, we sort of have to be mindful about the fact that we are facing a deep recession. The threat that this poses, and I think we as an industry have to acknowledge this threat, I think that it’s very likely that ESG investing may have to take more of a muted backseat over the short-term, whilst the economy gets back on its feet.

But I don’t think that necessarily means that it gets pushed down the list of priorities; I think if anything it may actually push it further up the priorities. Because if you combine the impact of Covid and its economic consequences, that to an extent has put certain vulnerabilities under the microscope. If you think about it, part of ESG investing in general is to address some of these vulnerabilities.

I think Covid has genuinely exposed a real lack of preparedness from both businesses and the wider society to an extent. Obviously, ESG investing can help address this. So I think it is going to remain a key priority for policy makers going forward.

David Thorpe:             

Thank you. Steve, as somebody who communicates regularly with advisers on the ground, do you think that perhaps the change to business climate might mean that they have to reappraise how they look at responsible investment, funds and products, and how they build that into their product offering?

Steve Kenny:          

I think certainly I would concur with what Ryan said; I do think there may be an initial perspective that this might be slightly on the back foot. But I think what we’re hearing from IFAs is their interest from clients has never been as strong. We’re being asked more and more to assist IFAs in terms of providing governance around responsible fund panels, responsible managed portfolio services. So the demand is definitely there.

I also think in the general media, in the national press, the coverage that these types of vehicles are getting has brought them to the attention of the general public which I think is really positive. So they’re actually going into their adviser’s office and asking about this. Whereas before I The final point is the asset management community, because they can see this regulation coming, are actually preparing funds that will meet the new demand. You can see that not only from the likes of Royal London, Fidelity, BlackRock, et cetera – the whole market is starting to deliver vehicles that have responsible, sustainable impact goals within their investment objective.

So you’re actually starting to get more awareness, and that in itself, will become almost self-fulfilling.

David Thorpe:                   

Thank you Steve – that’s great. Ryan, what are the areas that you think will be the focus on regulators’ thoughts in the years to come? Do advisers looking at this have a kind of runway that they can look down to see what will happen in future?

Ryan Medlock:        

Yeah, I think they do to an extent. I mean we already have a very good indication of what’s coming from an EU angle. You can see the focus there is very much on improving disclosure and transparency. I mentioned earlier about the taxonomy; I think that’s going to be a huge driver there in improving disclosure. Ultimately, as an adviser, you’ll be able to look at certain funds and you’ll be able to see what proportion of that fund invests in taxonomy eligible activities for example. So that’s going to massively improve transparency there.

It’s also going to be extended to cover social and governance issues as well. It very much focuses on the environmental side at the moment – so that’s a big driver. I think as well there’s plenty of issues, from an adviser perspective, that continue to persist with ESG data in general. So I’m talking about whether that’s the liability, the debts, consistency of data; I think it’s going to be really, really interesting to see what type of measures are going to be introduced to improve the standards of reporting going forward.

You’ve got the TCFD – the Task Force on Climate Related Financial Disclosures; that could have a really big impact here in terms of setting standards for financial companies to disclose, and whether these ultimately become mandatory measures. So you can see, from a high-level perspective, the big-ticket themes that I think are going to be focused on for a couple of years, and it’s going to be interesting how that gets filtered down into the various chains underneath it.

David Thorpe:           

Thank you. Steve, from your point of view, you mentioned earlier the advisers questioning around what these different terms mean – sustainable, responsible, ESG, et cetera. Is that an area that you think perhaps regulatory spotlight could shine on and give some clarity on in future?

Steve Kenny:          

I think it could, but the Investment Association I think have made a pretty good attempt at trying to introduce a common framework of language that the industry could utilise in describing either responsible or sustainable or impact – so we have consistency of definition. I think that – if that comes to be adopted by the asset managers – that will help. Because I think then everybody will be talking the same language, the marketing material will be using the same type of terminology which I think will also help the end adviser because they’ll feel comfortable in talking about this investment opportunity in the knowledge that there is this consistency of terminology.

I think the point that Ryan makes is really interesting about data because I think that’s going to be one of the big challenges facing this because I think there is a real sense of positivity about the advent of responsible investing. But it’s going to be that consistency of data that allows advisers to compare and contrast different funds and have a meaningful conversation with their client to ensure that they understand the type of vehicle they’re investing in.

So I think the regulator could play a part, but I think the industry has already made some start to try and get commonality of language.

David Thorpe:       

Thank you. Ryan, the general theme I guess of your remarks so far is that really the regulatory environment has provided lots of clarity and lots of help and a great boost to the responsible investing universe. But are there areas of the market and sectors within ESG sustainable investing, et cetera, that you kind of want to avoid due to the regulatory outlook?

Ryan Medlock:        

Well I wouldn’t say there’s any particular areas that you would say you would avoid due to a regulatory outlook. I mean within the broader term of responsible investment, and obviously Steve just went over some of the key approaches there which were outlined in the Investment Association’s framework, which I must add to as well, is an excellent read and I definitely encourage everyone to take a look through that.

But obviously there’s a lot of different approaches applied in there and even when you drill it down and look specifically at ESG integration, there isn’t really a one-size-fits-all to all of this. I think there’s lots of pros and cons with each approach, and you can really drill that down into a granular level. If you take exclusions as a responsible investment approach in its own right, you could argue that exclusions as a sole responsible investment approach is perhaps too simple.

I mean there’s no doubt that it’s the purest way of avoiding something. But you could argue that by just focusing on exclusions, you’re sort of ignoring the issue and shifting the issue elsewhere, and it also obviously reduces the investable universe for the manager as well. So you could take a look at exclusions in its own right and you could say well perhaps you can make it more purposeful if you combined it with another approach, say positive engagement for an example.

So I think that the responsible investment universe is littered with examples like that. But I wouldn’t say that there’s specifically areas that you would look to avoid due to the regulatory outlook.

David Thorpe:                 

Thank you. Steve, from your point of view, from the conversations you have with advisers, are they starting to identify which bits of the responsible investment universe they want to be putting clients into? And perhaps those that they want to avoid, or those that they’re uncertain about, due to the broader regulatory world in which we live?

Steve Kenny:          

I think it comes down to the personal preferences of the client. I had a really interesting conversation with an adviser the other day and he was talking about how – what a good position we’re in terms of [unclear] becoming so popular in terms of the media and all of that. He said one of the things he was really keen on is that we didn’t have the situation where we effectively took – so capital not deployed for some of the industries that need to be changed.

The point that Ryan was picking on I think is a really important one. By having capital within a business you have the ability to influence and he was really keen that he didn’t – we didn’t see a rise, a wholesale rise in terms of exclusion-style investing. Because he felt the opportunity was more pronounced for the asset management community to instigate change in business for a positive nature. He was actually suggesting we almost had like a [funds launched] that were investing in areas that needed the most change, almost like I suppose the green funds, brown funds. And you’re actually looking to invest in businesses where there was the most significant degree of change required and utilising your capital in that concept.

So I don’t think people are looking to exclude any style of investing, but it depends on the client’s preferences when they walk through the door, because some of these issues are really personal to the individual investor.

David Thorpe:    

Okay, so thank you Steve, that’s very interesting. Steve and Ryan, thank you very much for joining us today on the podcast; enjoy the rest of your day, and tune in next time for the next edition in our special series of podcasts on responsible investing. Thank you.

About the author

Ryan Medlock

Senior Investment Development & Technical Manager

Ryan’s journey with Royal London began back in 2008 after starting his career in compliance with Norwich Union. As an Investment Proposition Manager, Ryan contributed to the growth and development of Royal London’s Governed Range before moving to Aberdeen Standard Investments for a stint in the Strategic Client’s relationship team. Ryan returned to Royal London in 2018 with a focus on exploring adviser angles amongst complex regulation and investment themes. Ryan is involved in developing adviser facing content, presenting, writing articles and commenting for the press. Ryan holds the IMC qualification. Ryan is particularly proud of the fact that he finished 952nd in the 2008/09 edition of Fantasy Premier League.

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