Network managers go green and digital

Network managers make waves with ESG

Sparked by growing client demand and the introduction of new regulations, such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) and the Corporate Sustainability Reporting Directive (CSRD), financial institutions are putting a growing emphasis on ESG issues.

Network managers are no exception.

Although ESG is not something which traditionally sits within network managers’ remits, many are starting to scrutinise their agent banks’ sustainability policies and procedures in more depth.

Massabni noted that some network managers are incorporating more probing and granular questions on ESG into their RFPs during the agent bank selection process. Some RFPs may ask agent banks to provide tangible or statistical evidence outlining how they promote diversity in the workplace, or prevent gender pay gaps from emerging.

ESG is also referenced fleetingly in the Association for Financial Markets in Europe (AFME)’s standardised due diligence questionnaire (DDQ). According to Massabni, the ESG questions in the AFME DDQ are mostly high-level and are not aimed at agent banks specifically, but rather on how ESG is applied at a group-wide level.

For instance, Section 3.9 of the AFME DDQ contains a number of questions tackling ESG, including on whether ESG considerations play a role in the client onboarding process and KYC assessments. Additionally, the DDQ asks banks if they – together with their third-party vendors - have any specific due diligence or exclusionary policies when accepting business from specific sectors (i.e. coal, oil, tobacco, etc.).

“Global custodians do not want to suffer the reputational damage of working with an agent bank, which at a group level, might have poor ESG. For example, some global custodians may think twice about appointing an agent bank if its parent company is heavily involved in the financing of controversial weapons,” said Massabni.

However, ESG is not without its challenges at a network manager level.

Firstly, there is a lingering debate about whether network managers have sufficient subject matter knowledge to be quizzing agent banks about ESG. “Everybody – including network managers - are having to upskill as the market changes and evolves. Nonetheless, a lot of network managers are leaning on ESG experts at a corporate level for support,” said Massabni.

A more serious issue facing ESG is regulation. Massabni highlighted a number of global regulators are introducing rules around ESG and sustainability, which is creating complexity for the industry. As these rules are rarely aligned with each other, it means financial institutions often find themselves having to comply with different regulations across multiple markets.

Another problem, continued Massabni, is the absence of standardised ESG data. Today, financial institutions are being overwhelmed with different ESG data standards, which are being pushed out by an assortment of industry associations, pressure groups and ratings agencies.  Without a common ESG data standard, financial institutions are using their own tailored methodologies when measuring ESG, resulting in inconsistencies.

While network managers understand the “G” component of ESG and are slowly getting to grips with the “S” element, Massabni said more work still needs to be done on the “E.” He also noted that firms should concentrate more on biodiversity risk, given how closely intertwined global GDP is with the natural environment.

Although network managers are by no means ESG specialists, this is a subject matter which they are quickly having to familiarise themselves with.

How network managers are having to adapt to the rise of new digital assets

With investors looking for new sources of returns, many are starting to add digital assets – including crypto-currencies – into their portfolios.  Although crypto-currency investing has historically been retail-orientated, institutions, such as hedge funds, are starting to pile in as well. At the same time, larger investors are taking a growing interest in more regulated digital assets, including security tokens.

While the security token market is much smaller than crypto-currencies, experts are anticipating it will increase in size quite significantly over the coming few years.  As more clients participate in digital asset markets, banks are having to develop solutions to support them, according to Marochini.

In the case of Societe Generale Securities Services, Marochini said the bank can now act as a recordkeeper, valuator and liability manager for regulated asset managers (i.e. those subject to the Alternative Investment Fund Managers Directive [AIFMD]) trading crypto-currencies. “Most banks do not support clients trading crypto-currencies, so we really are an exception here,” highlighted Marochini.

Other providers are eschewing crypto-currencies but are instead developing digital asset custody capabilities for regulated digital securities only.

Societe Generale has a strong footprint in the world of regulated digital securities. Marochini continued that Societe Generale - FORGE, a fully integrated and regulated subsidiary of Societe Generale group dedicated to digital securities, supports the issuance of digital securities using Blockchain technology.

For example, Societe Generale - FORGE worked with the European Investment Bank on a €100 million digital bond issuance in 2021. More recently, Societe Generale Forge launched EUR CoinVertible, a Euro denominated StableCoin, as the bank continues to bridge the gap between digital and traditional capital markets.

So, what does this mean for network managers?

Just as network managers will review the operations of sub-custodians, cash correspondent banks and financial market infrastructures (FMIs), they will need to start incorporating digital asset custodians and other crypto-asset service providers into their due diligence assessments.

 This shift towards digital assets will also need to be reflected in the AFME DDQ.

“Digital asset providers still need to be assessed from a risk management point of view, Network managers will need to evolve their competences, and this will require them to amend their due diligences and ask different questions from what they would a traditional incumbent,” said Marochini.

He continued: “Network managers must ask crypto-asset service providers about what types of crypto-assets they are looking after and the Blockchain protocols which they use. They will need to review their providers’ cyber-security measures and get an understanding of what sort of cryptographic tools they leverage. In light of the FTX episode, network managers will want to see evidence that providers fully segregate client funds from their own and are subject to regulation. And finally, they will want assurances that their providers have sufficient balance sheet capital.”

Appetite for digital assets – despite last year’s crypto-winter – is only moving in one direction. As more digital asset service providers enter the fray, network managers must adapt and modernise their due diligence approaches.

What next for network?

Network management is going through a period of transition amid the rise of ESG and digital assets. Agility and a willingness to embrace change will be vital if network managers are to stay relevant moving forward.

Fouad Massabni, Head of ESG Offer, SGSS & Laurent Marochini, Head of Innovation, SGSS Luxembourg

Article published in Global Investor in July 2023.