Regulation for ESG 

Global Investor held their inaugural ESG Roundtable in June. It was moderated by Roy Zimmerhansl who led an engaging discussion with the diverse panel on ESG integration in portfolios to regulation to practical implications and much more. 

A portion of the 2023 ESG Roundtable is available in the video above. See below for a transcript of the highlights. 

Roy Zimmerhansl (RZ): I want to move now on to the second segment, really which comes up quite a lot, which is ESG and regulation and I think we’ve touched on it in the last segment, a little bit, but, you know, again, if we’re talking about global, there is no such thing as global and it’s even arguable that whether there’s anything regional. You could say that country by country there is a question mark, right? So Jane, again, since the starting point for this is what investors are doing, what their investment managers are allowed to do or mandated to do, maybe you can start with that, about the regulation landscape even.

Jane Wadia (JW): Speaking for many in this industry particularly within asset managers and asset owners: a couple of years ago, probably none of us had heard of the four-letter words - SFDR - and now, that’s part of everybody’s daily life effectively. So there has been a significant push, at least in the European Union, but as you say, it is not just regional and it’s definitely very much country specific. We see increased regulation everywhere, including here in the UK where we’re doing this event today.

The UK FCA has announced that they will have SDR, their version of SFDR, the intent of the regulation is really good. I mean, effectively, what it’s trying to do is protect the end investor, make sure that when we’re talking, that we are investing sustainably, that we’re providing some context and framework and certainly disclosures around what that actually means, and that we’re able to explain it to our clients. Alongside the transparency and disclosure and reporting element, there is also obviously the intent behind it to help support direction of capital towards more sustainable investments. So in terms of the intention, absolutely, very supportive of that, and think it makes a lot of sense and tries to avoid errors such as greenwashing.

RZ: The lack of consistent regulation, does this that make it more challenging and what does it throw up for you guys?

Harpreet Bains (HB): Generally, in our capacity as service provider we are not directly impacted by the regulations that we’re talking about here, but by virtue of the fact that our clients are, then this has a knock-on impact on how we have to think about our product offering.

I’d begin by first reiterating what Janes just mentioned, that regulations play a key role in the overall ESG integration journey.

Without reg standards, it would be difficult to establish consistency, transparency, accountability They are really important for holding companies accountable for their ESG performance and providing consequences for noncompliance. Without regulations you potentially risk the erosion of investor confidence. For example, without disclosures, it would be very difficult for investors to assess ESG performance, and we’d see increased concerns about the accuracy and the reliability of the information which ultimately makes it much harder for investors to then be able to actually identify and allocate capital to sustainable investments.

We have to remain mindful that it’s an evolving landscape at national, regional, global level. The regulations are not only impacting portfolio construction but also, engagement, reporting, and following some recent MIFID revisions now also extending to investment advisory and distribution models.

Donia Rouigueb (DR): I agree with everything said before, and I think that the good news is that despite all the regulation, we can still engage in securities lending, and regulators are fine with that. SFDR has been a real concern for our clients and there have been major questions amongst all the participants. I agree that we need greater harmonisation but regulations will never spell out exact rules, it’s often guidelines that leave some space for interpretation. They provide a good framework but we need greater harmonisation between jurisdictions to align specific regional approaches or national differences that can’t be handled at local level.

RZ: One of the things about regulation is the two phases to it. One is we see the implementation of regulation, but then regulators feel compelled to make certain it’s being enforced, and we’ve seen fines and challenges by regulators in many jurisdictions now. So when you’re thinking from your investment manager point of view, that’s got to be on your daily agenda, really taking that into consideration.

JW: I don’t know if it’s accelerating but as you said, regulation has been around for years and if it’s there, it needs to be applied and enforced and if it’s not enforced, it needs to be dealt with, fines or whatever. What we’re seeing with the regulations around ESG is they are coming in thick and fast, and they’re different in different countries, etc. We’ve worked really hard to make sure that we comply, certainly with level two that came into effect on January 1 this year but I think as, as others have mentioned as well, I would expect that in this landscape, because it’s so fast evolving, that this regulation is also going to evolve over time.

Ultimately it is there to help transparency, accountability on the financial markets effectively, to ultimately be providing clear messages to our clients so that they know what they’re investing in effectively and what they’re allocating their capital to.

DR: I think that regulators themselves are aware that everything is evolving and are trying to find a common position for the ESG framework. There is still room for discussion and the evolution process will continue.

RZ: When talking about regulation generally, ESG and others. That’s placing a big burden on the service providers, investment managers, securities lenders, and all of that. So do you see that as a big part of your budget spend and is keeping on top of it really a big part of where you’re allocating resources, time, people. Is that now just a benchmark that says: we have to do this and that’s a sunk investment because you’re not charging more because of it?

DR: Actually, there’s major pressure on service providers because of rising costs: more regulation, more reporting, IT development requirements. As we mentioned at the outset, ESG is here to stay, and we agree that it’s a good thing, but it requires the implementation of new tools to manage new demands such as automatic recalls and specific collateral selection criteria.

In Europe, there is growing pressure on the revenue splits most agent lenders have established with clients. At some point, lending agents and clients will have to discuss the economic viability of current pricing offers, now that there are many new additional costs.

HB: Are you doing ESG regulatory reporting for your clients?

DR: We are a custodian, so we have to do all the reporting. More regulation means more responsibilities, and more responsibilities means closer monitoring of our clients.

You have to ensure that the client’s requirements for the lending program are properly applied. For instance, let’s take voting and automatic recalls - there’s data you have to have and that data has a cost. Also, depending on the country, there are different rules to ensure recalls are performed on time. Automation helps, and the new costs doesn’t mean that a securities lending program can’t be profitable, it’s just that every time a new rule or requirement is added, it impacts that profitability.

HB: The product and operational changes that we’re taking about can’t be managed effectively without automation otherwise you’re increasing your manual risk and creating process inefficiencies. Investing in the necessary technology changes is something we’ve been fully committed to from the beginning.

There is cost to develop infrastructure to support your client’s ESG goals, that point has been made. A different point which I think is probably even more prominent is remaining mindful that these preferences can have revenue implications for your lending program, therefore striking the right balance when setting ESG policies is crucial.