ESG – Voluntary vs. Regulatory? Both?

Green Finance Regulation: a need for a Harmonised Framework

While there is widespread agreement on the importance of considering Environmental, Social and Governance (ESG) factors in investment decisions, the implementation of sustainable finance and "green" investment objectives set by the European Commission is a gradual process. To make it happen, a significant shift in mindset and approach towards sustainable investing has to be fully realised first, requiring further education to raise awareness of environmental impacts.

The progress of ESG data and analytics services is necessary to improve interpretation and understanding of the Sustainable Finance Disclosure Regulation (SFDR), which currently lacks standardised and harmonised ESG disclosures. The European Securities and Markets Authority (ESMA) published a supervisory briefing in May 2022 emphasising the importance of supervisory convergence among National Competent Authorities (NCAs) to support those transformations and finally enable easier comparison of ESG products.

Asset managers, as financial market participants (FMPs), are today required to comply with SFDR and the EU's Framework Regulation without having all the cards in hand. However, their regulatory landscape is due to expand further and their access to better quality data improve with the introduction of the Corporate Sustainability Reporting Directive (CSRD), formerly known as the Non-Financial Reporting Directive (NFRD).

On 28 November, 2022, the European Council officially approved the CSRD, which aims to enforce precise and comprehensive extra-financial reporting by European companies through an annual published report. This future directive's objective is to enhance the disclosure, communication, reliability and quality of information provided by companies on environmental, social, and governance matters.

CSRD will ensure alignment with other EU regulatory initiatives on sustainable finance such as SFDR and the EU taxonomy regulation. These alignments will play a crucial role in helping asset managers meet their compliance obligations, particularly regarding SFDR level 2 reporting requirements.

As we move forward in 2023, these regulatory developments are expected to contribute to a more transparent and sustainable financial ecosystem, driving the alignment of investments with environmental and social goals.

The Rise of Voluntary Commitments: Long-term Value Generation

In recent years, a growing number of asset managers and asset owners have been voluntarily committing to responsible investing practices. By way of an example, as of June 2023, more than 315 asset managers with USD 59 trillion in AUM* have committed to the Net Zero Asset Managers initiative. This list includes Blackrock among others, despite recent investor and political pressure to re-evaluate their ESG strategies. This shift reflects a broader recognition of the importance of Environmental, Social and Governance (ESG) factors.

Asset managers are meeting the increasing investor demand for sustainable and socially responsible investment options by adopting voluntary commitments that align with clients' values, promote climate action, diversity and inclusion, and ethical business practices.

Responsible investing not only meets investor demands, but also manages risk and generates value, as asset managers integrate ESG analysis into their decision-making to identify risks, seize opportunities and create resilient portfolios.

Voluntary commitments enhance asset managers' reputation and build trust with clients, stakeholders and the public, showcasing their dedication to sustainability and corporate social responsibility.

Recognising responsible investing as a long-term value creation strategy, asset managers identify companies with sustainable models, innovative approaches and strong governance practices, enhancing long-term value generation and contributing to a sustainable financial ecosystem.

Lastly and most importantly, proactively embracing responsible investing aligns asset managers with evolving regulations and positions them as industry leaders, adapting to changing market dynamics and potential mandatory requirements.

How to Align and/or Combine Regulatory and Voluntary Commitments on ESG matters:

Combining regulatory and voluntary commitments on ESG matters can be a complex task for Asset Managers and Asset Owners, but it is essential in order to create an effective ESG investment strategy and meet sustainability goals. It is a long-term endeavour that requires dedication, continuous improvement and engagement.

It starts with understanding the prevailing ESG standards, guidelines and framework in the industry. This includes international standards such as the United Nations Principals for Responsible Investments (PRI) and Net Zero commitments to achieve net zero greenhouse gas emissions across investment portfolios by 2050 or sooner, in line with global efforts to limit global warming to 1.5 degrees Celsius.

It also goes hand in hand with engagement and active ownership. Asset Managers must engage with companies in which they invest to encourage them to adopt sustainable practices aligned with the commitments made. This is particularly true and effective in the private markets, where asset managers must actively engage with their investees for better ESG risk management and long-term value.

How should one choose the voluntary framework? It starts with identifying goals and objectives of what the asset manager is looking to achieve, i.e. promote sustainable practices or enhance climate resilience.

Challenges to transition

Considering private assets more specifically, measuring and reporting sustainability-related risks and opportunities is essential for an effective decision-making process. However, there is a lack of standardised data and metrics to assess the sustainability performance of companies and investments.

Whilst for listed companies the data is available via the various data providers, getting access to ESG data for private market Asset Managers is another challenge they face.

Indeed, in the absence of being able to purchase the data from data providers, private market Asset Managers must collect and interpret the data themselves, which is quite a challenge. In recent years, we have seen several examples of companies having very good ESG scores ending up with an ESG scandal. On top of being exposed to ESG risks directly, Reputational risk can also put companies in great difficulty.

This is something for asset servicers to actively contribute to, through services ranging from helping asset managers navigate the regulatory frameworks, gathering and analysing data, helping them comply with ESG reporting and disclosure requirements and associated performance monitoring and, last but not least, engagement associated with action plans for both a better future and better valuation!

Fouad Massabni, Head of ESG commercial offer, Societe Generale Securities Services and Jean-Pierre Gomez, Head of Regulatory & Public Affairs Societe Generale Securities Services Luxembourg

* The Net Zero Asset Managers initiative – An international group of asset managers committed to supporting the goal of net zero greenhouse gas emissions