Fiddich Review Centre
Alternative Investment

ESG Certification: Assisting In Mitigating Greenwashing For Investors, Managers, Funds And Regulators – Fund Management/ REITs

There have been numerous positive developments in the evolution
of ESG investing. Still, the research needed to assess which
investments are truly ESG-compliant and which are tantamount to
greenwashing is burdensome. It is estimated that US asset managers
spend over US$200million on ESG research each year, and the cost
associated with discerning if a fund is meeting its ESG mandates
can be prohibitive, write the authors of this article. What the
industry needs is a thorough and independent ESG assessment
certification for fund managers and funds, they explain.

Assume the following scenario: You are a fund manager that wants
to make a real difference as you generate returns. You have
answered the call of your investors. You have in place the due
diligence, research and investment process for environmental,
social, governance (“ESG”) or impact investing. Yet you
encounter skepticism and increasing requirements to demonstrate
that you are contributing to societal good.

Your fund’s ESG rubric is proven. Yet misgivings remain
after other actors in the space have fallen short from the
standards set in the asset management industry. For example, a
university endowment with which your firm has a new possible
mandate is still reeling after the board uncovered greenwashing in
another set of its investments—or a pension fund your firm
has been courting which has had to confront media coverage showing
its recent allocations have connections to corrupt national
governments. To demonstrate your ESG rubric, you need to satisfy
investors and regulators that you are doing what you say you are
doing. If your fund has done its side of the deal, how can the fund
quantify all of this work to potential allocators and
regulators?

When it comes to ESG, funds and managers are struggling to
showcase and validate their initiatives. A clear framework and
methodology for independent ESG reporting and certification could
help overcome this issue and can increase credibility with respect
to their ESG strategies. Through collaboration among key
stakeholders such as asset managers, service providers, consultants
and academic researchers, the industry can strive to set the
standard for what constitutes true ESG investing certification.

The ESG Evolution

The concept of institutional investment is rooted in managing
money dedicated to a community’s general good and emerged
alongside the rise of ancient civilisations. Examples include the
Greco-Roman campaigns for the wealthy to donate a portion of their
funds to public coffers or, in the medieval Islamic world, the
waqf, a funding pool that would go toward developing education and
public infrastructure. The earliest forms of ESG investing
developed along similar lines. Those with oversight of these early
institutions developed guidelines for investing in what was
considered permissible according to their religious, moral or
societal standards.

Socially responsible investing in the popular sense as we know
it today, gained ground in the 1970samid a societal awakening to
environmental issues and outcry against the Vietnam War.

Later in the decade and into the 1980s, outcry against the
apartheid movement and environmental concerns such as global
warming entered the conversation.

ESG awareness and investing continued to gain traction through
the 1990s and 2000s, with the institution of the UN Principles for
Responsible Investment (“PRI”) in 2006 making the biggest
waves in the asset management industry.

The PRI was the brainchild of then-UN Secretary General Kofi
Annan, who had some 20 of the world’s leading investment minds
as well as 70 experts from across government, business, and society
convene to discuss how environmentally and socially conscious
investing is part and parcel of fiduciary duty to shareholders. The
risks inherent in climate change, endemic corruption, and civil
liberties should be considered alongside other investment
decisions, as they pose as much concern to a fund’s returns as
do factors traditionally taken under advisement when making
portfolio allocations. Essentially, as elaborated in the six
principles, the investment community cannot afford to overlook ESG
concerns—and it is to its benefit to embrace them when
building out strategies.

As of May 2022, the PRI has 4,902 signatories, accounting for a
total US$121 trillion in assets undermanagement. The UN encourages
asset managers and service providers that have joined on to the PRI
to “publicly demonstrate [a] commitment to responsible
investment and [place] it at the heart of a global community
seeking to build a more sustainable financial system”.

These principles have spurred the evolution of sustainable,
responsible and ethical investing into what it is today. Topics
that were previously the focus of policy roundtable discourse have
become headline news across financial forums and business media.
Most importantly, these ideas have become an inextricable part of
investors’ evaluation process when selecting fund managers. It
is no coincidence that the board of the UNPRI includes
representatives from some of the world’s largest and
best-performing pension funds, such as California’s CalSTRS,
Norway’s NBIM, and Sweden’sAP2.

ESG in the Asset Management Industry Today

Those pension funds on the UNPRI were among the early adopters
of ESG investment philosophies but today it is the standard for
many large institutional investors to require a certain threshold
of ESG-related funds in their portfolio. With allocators of such
caliber driving demand, the majority of asset management firms have
now, by and large, embraced such strategies.

According to K2 Integrity, a New York-headquartered consultancy,
78 percent of asset managers now incorporate ESG into their
investment allocations. According to Morningstar, as of the first
quarter of 2022, more than 2,000 asset managers globally handle
some US$343 billion in sustainable funds, with such strategies
taking in more than US$96.6 billion in net new deposits over the
period. ESG options continue to evolve to meet the demand. Over the
course of 2021, US investors launched 121 new sustainable funds,
bringing the total available to US investors to 534,marking
year-on-year growth of 36 percent.

European asset managers, in particular, have been at the
forefront of the ESG investing wave, with regulations and
disclosure requirements further ensconcing these principles into
portfolio construction. The EU’s Sustainable Finance Disclosure
Regulation (“SFDR”), which first entered into force in
December 2019 and began to apply across the 27-nation bloc since
March 2021. The EU’s Taxonomy Regulation, which has been phased
in since the start of 2022, builds upon the SFDR to stipulate that
“financial market participants,” which includes
alternative investment fund managers, portfolio managers, and
UCITS, to disclose the proportion of environmentally sustainable
business allocated in the portfolio compared to other
investments.

Within the UK, the country’s Financial Conduct Authority
rolled out its own set of rules late last year alongside the
Recommendations of the Task Force on Climate-Related Financial
Disclosures. Also in the works is a proposed sustainability
disclosure regulatory with products and firms to be labelled
according to how climate risk gets factored into investment and
corporate decisions along a five-level system ranging from
“not sustainable” to “impact.” These
advancements across Europe are expected to influence US regulation
as well. Stateside, the SEC’s push in March for ESG disclosure
in portfolios has put managers on alert.

While these developments have been positive for both managers
and investors, the research needed to assess which investments are
truly ESG-compliant and which are tantamount to greenwashing is
burdensome. It is estimated that US asset managers spend over
US$200 million on ESG research each year. For the boutique manager
and the major market maker alike, the time and cost associated with
discerning if a fund is meeting its ESG mandates can be
prohibitive. While regulators have drafted outlines to set some
ground rules on ESG, there remains no clear consensus in many cases
on what constitutes ESG investing and what is merely portfolio lip
service. In some cases, overselling a financial product could be
intentional, but more often, a misalignment on ESG could be a
matter of differing perspectives between the buy-side and sell-side
on what constitutes compliance.

The Independent ESG Certification Solution

An independent ESG evaluation and certification could address
this problem and can support better alignment between managers and
investors – and regulators – when making allocation
decisions. Instead of managers self-reporting, independent
certification would provide a thorough review of their approach and
processes to help validate and quantify ESG initiatives and ensure
they are following through on their commitments.

Tools that employ industry best practice, take the highest
industry standards and global regulations into consideration, and
harness the perspectives of the leading ESG legal, investment,
operational, compliance and technological minds can help pave the
way for a beneficial shift in the industry. At the moment, however,
the industry remains reliant on self-certification by funds and
managers. How could such a shift come about?

K2 Integrity, in partnership with the Maples Group, has
collaborated with leading investment managers and academics from
such renowned institutions as Cornell, Carnegie Mellon, Columbia,
and University College-London to develop a robust, thorough,
meaningful and independent ESG assessment certification for fund
managers and funds.

The result is a unique, first-of-its-kind product for
independent ESG certification for alternative investments that is
forward-thinking, innovative and inherently designed to evolve with
the industry. Fund managers can look to this tool for guidance on
allocations that meet ESG credibility standards and are aligned
with industry best practices and jurisdictional regulations. This
approach allows fund managers to feel confident that their
investments are contributing to the common good. In other words,
institutional investment as it was originally intended.

Co-Authored by Mark Weir, Deputy Global Head of Fund
Services at the Maples Group and a member of firm’s Executive
Management Team.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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