November 22, 2017
By RIA Staff
There’s no question that environmental, social and governance (ESG) factors present risks and opportunities that all investors should know about. But the burgeoning industry is evolving quickly with stakeholders on all sides trying to firmly grasp the implications for the market.
To identify and evaluate the challenges and opportunities for the growth of responsible investing, we launched RI Week 2017 by posing a question to leaders in the field: what’s next for market development? Detailed below are four central themes that emerged during an hour-long exchange with experts at the 2017 RI Week Market Open on October 23rd in Toronto.
Special thanks to panelists Heather Cooke of Fiera Capital, Judy Cotte of RBC Global Asset Management, Michael Jantzi of Sustainalytics, Hyewon Kong of AGF Investments, and our event host and sponsor, NEO Exchange.
1. Barriers & Challenges for Responsible Investing
“There’s a lot more we can do to standardize ESG data but we cannot wait for it to be perfect.” – Hyewon Kong, Associate Portfolio Manager, AGF Investments Inc.
Standardizing ESG disclosure and market education remain among the most significant challenges to RI market development. The two are intertwined by the investment community’s need for accessible, comparable, and reliable ESG information to make informed investment decisions.
ESG Disclosure Practices – Without access to comprehensive and comparable ESG data, investors’ ability to factor ESG issues into their decisions is restricted. Since disclosures are not standardized, it is difficult for investors to make ‘apples-to-apples’ comparisons across asset classes.
Measuring ESG Performance – Investors find it challenging to measure and track the sustainability performance of their portfolios. Having the ability to measure and track ESG performance in addition to financial performance would provide investors with a clearer picture of how responsible investments are contributing to positive societal change over time.
Issuer Education and Engagement – Issuers are often faced with ‘reporting fatigue’ and are unsure which ESG data is relevant to investors and how to present it. This is most apparent in Corporate Social Responsibility (CSR) reports which lack transparency and consistency, and are published separately from financial disclosures.
Financial Professional Education – The lack of concensus around ESG disclosure and materiality also makes it difficult for some Portfolio Managers (PMs) to understand what ESG is and why it matters. Many PMs operate with a limited or dated understanding of ESG, and as a result, fail to see the value of integrating it into their decision making. For example, one common misunderstanding is that ESG integration restricts one’s investable universe.
Passive Investing – Stewardship and shareholder engagement, which are major aspects of responsible investment, could be challenging in the context of growing interest in passive strategies.
Tracking Benchmarks – Benchmarking can be a challenge, particularly for impact and sustainability-themed investing.
2. Solutions & Resources for the RI Market Development
Although some of the challenges identified above are quite significant and require multi-stakeholder efforts, some solutions are within reach in Canada and have already been implemented successfully in jurisdictions around the world.
Mandatory & Standardized Disclosures – Mandatory and standardized ESG disclosure would allow for more effective and consistent ESG analysis and therefore better investment decisions. Recommendations from the Task Force on Climate-related Financial Disclosures (TCFD) provides one potential model for capturing and standardizing climate change exposure for Canadian companies. Implementing standardized disclosures could also be facilitated by stock exchanges, which could align their reporting requirements with frameworks such as those put forward by the TCFD and the Sustainability Accounting Standards Board (SASB).
Peer-to-Peer Dialogue – Investors and issuers need to share insights into ESG reporting and analysis. For example, while issuers are accustomed to reporting on environmental and social issues in their annual CSR reports, they may not be aware that the investor community wants to see more rigorous disclosures of material ESG information alongside financial disclosures. Investors must continue to engage and educate issuers to close this knowledge gap.
CFA Education – Although the CFA institute has taken steps to incorporate ESG education into the CFA curriculum, it remains a peripheral issue. Improving how ESG is taught to emerging investment professionals can directly shape how ESG is understood and applied in the market.
3. Regulatory Guidance
“We need more disclosure, yes, but better disclosure.” – Judy Cotte, V.P & Head, Corporate Governance & Responsible Investment, RBC Global Asset Management
Although responsible investing has been driven largely by market demand in Canada, a supportive regulatory environment could create a tipping point. While regulation would be helpful, mere comments or guidance from regulators could have significant implications. For example, in 2015, the US Department of Labor made a statement affirming that ESG integration is compatible with fiduciary obligations. Although this did not change the law, it provided an important market signal and greater clarity for market participants.
Stewardship codes provide another way for regulators to support the development of responsible investing. For example, in 2010, the UK Stewardship Code set out the principles of effective stewardship by investors. In so doing, the Code assisted institutional investors to better exercise their stewardship responsibilities.
4. Systemic Risk
“Systemic risk is next frontier for investment.” – Michael Jantzi, CEO, Sustainalytics
To fully manage exposure to social and environmental risks – and even contribute to their solutions – investors need to start thinking about systemic risk. For example, how are your ESG integration efforts mitigating or contributing to risks at a systems level? Described as the next frontier for responsible investment, systemic risks can impact corporate supply chains and consumer markets in various ways that are already happening in more vulnerable industries like energy and agriculture.
Portfolio managers need to consider the connection between operational and material challenges and the widespread effects of climate change. The Global Sustainable Development Goals (SDGs), as outlined by the UN, may provide a starting point for identifying the systemic risks that investors will face and a potential course of action.
Perhaps most importantly, investors need to think practically about their own future. As one panellist put it, what good is safeguarding pensions if 30 years from now pensioners can’t breathe the air or drink the water?
“Investors have the power to change society through capital.” – Heather Cooke, Deputy Chief Investment Officer, Fiera Capital
Responsible investing has made significant gains in recent years, now accounting for approximately 38% of AUM in Canada and 26% globally. While we must celebrate these achievements and the considerable momentum in the market, discussions with this panel – and throughout Responsible Investment Week 2017 – affirm that much work remains to be done to enhance current RI practices and to enable full market participation.
Disclaimer: This blog provides a summary of key aspects of the panel discussion that took place on October 23rd in Toronto. It does not represent any official positions of the RIA or its members.