Over the past five years, environmental, social, and governance (ESG) considerations have moved from the periphery to the centre stage as an important component of investment and asset allocation decision-making for many asset owners. Societal changes and international agreements, such as the Paris Agreement, have helped to foster greater awareness about how climate and broader ESG concerns can impact financial markets.
David Hickey, Head of Sustainability for BlackRock's UK business, and Mark Guirey, Executive Director - Asset Owner and Consultant Coverage at MSCI, shed light on the shifting tides of sustainability investing and where they see the industry moving.
The Past Five Years - Rising Expectations
Sustainability has become an important issue for many regulators and investors. Regulations have come thick and fast with Securities Financing Transactions Regulation (SFTR) and Sustainable Finance Disclosure Regulation (SFDR), as well as Task Force on Climate-related Financial Disclosures (TCFD) having been implemented.
In addition to changes in the regulatory landscape, each and every investor has different objectives. Hickey explains: "With greater understanding of how ESG factors can impact asset valuations, many asset owner clients - particularly long-term investors like pension funds - are asking how to mitigate risk and capture opportunities associated with sustainability and the transition in their portfolios. Some want to increase their exposure to the transition, some want to align their portfolios with a net zero pathway, and some want to achieve impact or sustainable outcomes in addition to financial return or to limit exposure to specific sectors. Others may choose not to invest using strategies that have sustainable investment objectives."
For asset managers like BlackRock, Hickey explains, "As a fiduciary, our approach to investing is grounded in three principles. One, we start by understanding the client's investment objectives. Two, we seek the best risk-adjusted returns within the scope of the mandate they give us. And three, we underpin our work with research, data, and analytics.
Hickey adds: "That means being as rigorous in analysing the impact of ESG factors on portfolios as you would any other investment factor. If you're incorporating ESG related risks and opportunities, it's not only about being more sustainable, but making sure you can monitor your risk more fully."
There has been a need to develop products that enable greater climate risk integration to meet client demand. Guirey explains that data providers have a key role to play in having decision-useful information ready across multiple asset classes. This can be a challenge in less liquid segments such as private markets and infrastructure.
Indexes provide a medium through which Pension Schemes can reflect their objectives, either by meeting and aligning with Climate Transition Benchmarks or Paris Aligned criteria set out in the EU Taxonomy or by employing more specific Low Carbon Indexes and other customized criteria in a rules-based index methodology.
The range of available indexes on the ESG and climate front has expanded to offer greater choice, to meet the ever growing needs of the market.
Additionally, data providers play a key role in helping clients seeking to further harness data supplied to them and keep up to date with regulations such as TCFD and SFDR. The sustainability landscape is constantly evolving, meaning index and data providers need to stay at the forefront of regulatory demands if they are to assist their clients.
The Role of Indexes
For ESG data to become integrated into more investors' portfolios, widely adopted indexes may need to capture more climate risk factors. Hickey and Guirey see a future where themes that were once the focus of niche funds, will become core components of major index funds too. Guirey: "A key area to watch for me is biodiversity. As biodiversity impacts are becoming visible, consider deforestation, wildfires, ongoing ocean pollution."
On top of this, Hickey explains that there will be greater granularity to the climate risk provided, with factors such as carbon and natural capital being captured. The aim is that more clients and investment managers will be able to see different parts of the investment ecosphere and have a comprehensive view of their climate risk exposure.
The Next 5 Years
However, while ESG data integration is becoming more readily available, it doesn't make it easy to implement. Guirey and Hickey acknowledge that data providers are working hard on how to define material issues and improve data availability on themes such as deforestation.
Guirey adds "There has certainly been a change in investors sentiment away from action that solely decarbonizes their portfolio and into the impact their actions are having on real world decarbonisation. This has an impact on how they engage and the information that Pension Schemes and Investors require.
Challenges also persist in other forms. Regulatory harmonisation is an ongoing process and the need for collective action remains key."
Hickey concludes: "We're aware of how much investment is required to make the transition happen. If we can provision the product choice that allows that money to flow, for me, being just a small part of that machine, is extremely exciting."
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