ESG and sustainable finance – issues for asset managers/intermediaries

Asset owners, as well as intermediaries in the financial services sector, are becoming increasingly proactive in their pursuit of sustainable finance strategies. This is often driven by a genuine desire to move towards more ethical and responsible investment; but increasingly, it is also a necessary commercial response to the demands of clients. Designing resilience to ESG risks is also an inherent part of investment risk management: protecting capital from hidden liabilities. As a result, ESG is about much more than just laws and regulation - firms and their clients are becoming more vociferous and more demanding about the sustainability credentials of products and funds in which they invest, and which they offer.

In many cases, this is driven by a genuine desire to move towards more ethical and responsible investment. In others, it is a necessary commercial response to the demands of clients next up the chain. Designing resilience to ESG risks is also an inherent part of investment risk management: protecting capital from hidden liabilities. As a result, even without the raft of new laws and regulation, firms and their clients are becoming more vociferous and more demanding about the sustainability credentials of products and funds in which they invest, and which they offer.

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Overview of relevant law and regulation

The ESG requirements of the investment community can be seen against a background of various, interlinking initiatives at the global, EU and domestic levels. These range from global efforts under the UN 2030 Sustainable Development agenda, the Principles for Responsible Investment and the recommendations of the Task Force on Climate-related Financial Disclosures; various EU measures under the European Commission's ongoing Sustainable Finance Action Plan which is designed to finance the European Green Deal; and the UK's own Green Finance Strategy. The UK Government has committed in its Green Finance Strategy to at least match the ambition of the EU Sustainable Finance Action Plan.

Enhanced stewardship requirements are provided for in the EU Shareholders' Rights Directives, already largely implemented in the UK via the UK's Stewardship Code and relevant provisions of the FCA Handbook.

Various EU legislative measures have been passed, largely focused on setting minimum standards specifically on disclosure and taxonomy and, although the UK will not adopt them directly, it seems clear that it will implement UK-specific versions. The UK has already begun work on its post-Brexit ESG regime, announcing that it will be first jurisdiction in the world to make reporting under the Taskforce on Climate-related Financial Disclosures mandatory, whereby reporting on climate change will be required by almost all UK-regulated asset managers (including alternative investment fund managers).

The UK will not implement the EU Sustainable Finance Disclosure Regulation (SFDR) in 2021 directly, although we expect it to implement a more principles-based version as a "UK SFDR".

The EU Taxonomy Regulation will define the types of activity that are “environmentally sustainable” for the purposes of EU-regulated investment activities claiming to focus on sustainability and is expected to play an important role in the development of green finance and preventing greenwashing. The UK has confirmed that it will implement a UK-specific version of the EU's taxonomy.

However, this is just the start. It is clear that legislators and regulators won't be satisfied with enhanced disclosure and transparency alone. There are already moves to make an express link between sustainability and the rules on regulatory capital and the remuneration of staff. There is a clear direction of travel, and a forward-looking manager, with ever more sophisticated analytical and monitoring tools at its disposal, will want to get ahead of the curve and remain there.

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Risks and opportunities

Risks

The asset management industry faces an inherent dual risk; not only the ESG risks facing their own business, but also those affecting the performance of their underlying investment portfolios. In the face of increased scrutiny from investors, regulators, the government and the media, the way in which they develop and publicise their ESG - and wider - sustainability strategies and credentials will be critical.

Opportunities

ESG can be a driver of enhanced investment performance, particularly in today's tough investment environment. Seeing sustainable finance as an opportunity, rather than a threat or a compliance burden, makes good business sense: there is likely to be a competitive advantage in getting ahead of the game. Firms at the cutting edge are going beyond traditional investment management, tick-box compliance with regulation and/or simply looking to mitigate the risks associated with non-ESG investing; instead, they are exploring ways of incorporating ESG investment into an expanded concept of what "impact investing" means, with a view to achieving a wide range of measurable benefits to society and the environment that are accompanied by a positive financial return.

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Best practice

As it becomes more evident what advantages effective ESG management can generate, the role of ESG inexorably moves from what was primarily an investor relations exercise into a fundamental policies and considerations which underpin the investment process and which are entrenched at all levels within the fund manager's business. In short, it is fast becoming a matter of culture.

So best practice goes well beyond simply having robust policies, legally enforceable documentation and a set of reporting procedures which are compliant with legislation and regulation. These will all be essential, of course, and we can help you with these, but an aspirational manager will want to go further to find genuine value creation, minimal downside risk and an ability to communicate the firm's sustainability ethos to investors and other stakeholders.

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Our work

Travers Smith continues to be part of the wider discussion with its clients and industry associations about the opportunities which sustainable finance present, but our expert lawyers can be there for you in particular when:

you need to understand what the law positively requires you to do
you reflect on the real legal liabilities that your promises to stakeholders can create
you wish to use the law as a tool to secure your sustainable finance objectives

Through our work with trade associations (notably Invest Europe, the British Private Equity & Venture Capital Association (BVCA), and the Alternative Investment Management Association (AIMA)) we contribute to engagement with policymakers and lawmakers and to the education of their members.

horizon scanning for the newest legal dimensions to sustainable finance and ESG
compliance with ESG, sustainable finance and stewardship disclosure requirements
bespoke training for decision-makers and fiduciaries, such as pension scheme trustees, on their obligations
the design of investment policies, governing documents and mandates to service providers, including primary fund documentation incorporating a clear and contractually-enforceable suite of provisions governing ESG issues
development and implementation of a communications strategy which articulates the manager’s approach to ESG issues

the design of governance tools, such as anti-bribery and corruption, anti-tax evasion, whistleblowing and other HR-related procedures
the documentation of products, such as green bonds and other financing facilities which incorporate sustainability and ESG factors
market and regulatory issues arising out of carbon offset, renewable energy trading and emissions allowance trading arrangements
operational regulatory, compliance and risk management services, including due diligence
crisis response
international litigation risk

Recent work

As part of our horizon scanning services, we are advising a number of financial market participants – including asset managers and trading venues – on the minimum legal obligations to which they will soon become subject in relation to responsible investment.

We have advised significant occupational pension schemes on their sustainable finance policies and strategies, in the context of wider sustainable business considerations, such as tax ethics.

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