How to Prepare for Rising ESG Fund Compliance Requirements
Once considered a trend, ESG, or Environmental, Social and Governance, has evolved into one of the strongest themes in today’s financial world. Recently, we’ve watched lawmakers move proposals from suggestions to new laws. Now, implementation woes are being felt widely as funds seek to comply with new legislation that is a challenge to interpret. [i]
Most fund managers will find themselves wrestling with new requirements soon if they are not dealing with them already. This article will provide tips for easing the burden and incorporating compliance into your operational processes.
Remember it is Also an Opportunity
There’s no denying that all these requirements are creating more responsibility and more compliance costs. Fortunately, there is a silver lining: new opportunities to differentiate your offerings and attract investor attention. According to an Investment Management Association of Singapore survey, more than two-thirds of Singapore fund firms see increasing investment into ESG strategies as the top expected growth driver. [i]
That’s not a surprise since the demand for ESG investments continues to soar. According to PwC’s Asset and Wealth Management Revolution 2022 report, ESG-oriented assets under management are expected to grow much faster than the market as a whole. This growth is strong in the U.S., Europe and also in the Asia-Pacific region, which is experiencing the fastest percentage growth of ESG assets. Even the Middle East, Africa and Latin America are seeing increased demand, albeit at a slower rate.
One reason for this strong demand is that 60% of institutional investors surveyed believe ESG has already resulted in better investment yields when compared to non-ESG equivalents. With demand growth outstripping supply, fund managers may be looking to retrofit existing products to cater to ESG demand.
Higher Fees May Counter Higher Compliance Costs
PwC’s report also noted that of the investors surveyed, 78% said they were willing to pay higher fees for ESG funds. [i]
That’s a good thing since compliance costs and risks are rapidly rising.
Worldwide Enforcement on the Rise
Financial regulators in The United States have made it clear that they intend to hold asset managers and companies responsible for ESG-related misconduct. The Securities and Exchange Commission (SEC) formed the Climate and ESG Task Force for this purpose. [i]
According to a recent Reuter’s article, the critical thing to be aware of is that this Task Force is not waiting for regulations to mature to act. Instead, based on some initial enforcement actions, it is applying longstanding disclosure and fiduciary duty principles to hold asset managers and companies accountable if their ESG disclosures are considered false or misleading.
They are not alone. The Monetary Authority of Singapore announced its first-ever guidance for ESG disclosure and reporting for retail ESG funds in 2022. [ii] That was after it introduced climate-related stress tests for funds. In addition, Singapore’s Green Finance Industry Taskforce also recently rolled out additional guidelines for asset managers. These moves are in response to calls for greater clarity from financial institutions.
At the same time, fund managers are facing difficulties complying with the European Union’s Sustainable Finance Disclosure Regulation’s level two standards, which just recently came into effect.
Other governments are paying attention and readying their protocols as well. Clearly, risks are high, with investors and regulators expecting more from the industry when it comes to ESG compliance and disclosure.
Steps You Can Take to Get Prepared
Given this new reality, how can you manage compliance and control related efforts and costs? Here are some ideas.
Act now, not later.
At this point, risks are high. Waiting can be costly in terms of compliance risk and opportunity costs, so it is much better to take action now. Put your resources into establishing prudent procedures instead of fending off compliance actions.
Make sure all ESG disclosures are adequately supported.
With enforcement ramping up, it is wise to revisit any existing ESG disclosures to make sure they are clear, specific and supportable. Look for references to general terminology that might be questioned by regulators. Be sure to include definitions of any terms you rely on for metrics.
Then, any new ESG disclosures or references should emphasize clarity and be well documented.
Create an infrastructure for ESG compliance, either internally or through outsourcing.
Knowing that ESG is not going away, building it into your business systems is necessary at this point. There are two ways: create your own infrastructure or rely on an outsourced option. Outsourcing can be cost-effective for many firms since it keeps your team focused on what you do best. You can also get access to better technology and advanced platforms, providing you with other competitive benefits. When outsourcing, however, be sure to carefully vet providers. You need a firm that will fit your needs today but also serve you well as you grow.
Integrate compliance personnel into the ESG process.
Because of increased regulatory scrutiny, it is critical to pay attention to ESG disclosures and practices as you would any other firm documentation or marketing. So, look at integrating your compliance team into the process of preparing any ESG reporting or statements.
Don’t Wait too Long
With ESG continuing to gather momentum, it is clear that today, risk lies in inaction. However you decide to handle it, be sure to prioritize this high-visibility aspect of your business. At the same time, remember to look for opportunities to use ESG to get even more exposure to investors looking to invest in sustainable ways.
Can Linnovate Partners help your firm achieve your ESG goals?
Contact us for a confidential consultation.
https://www.insurancejournal.com/news/international/2022/12/20/700106.htm
[1] https://www.reuters.com/legal/legalindustry/esg-enforcement-is-rise-are-you-ready-2022-11-16/ [1] https://www.ft.com/content/c436431a-436b-4bdb-857b-644237095fb8
