Sam Barrett examines the changing regulatory environment for responsible investing and ramifications for the financial planning profession
Crowing engagement with environmental, social and corporate governance (ESG) issues is driving demand for responsible investing, with figures from the Investment Association showing that nearly £90bn was invested in these funds at the end of October 2021. But, as the market grows, regulators are taking steps to ensure consumers and their advisers have the clarity they need to be able to invest in line with their principles.
The regulators’ concerns stem from the fact that responsible investing is a very subjective term. “The challenge is that the ESG universe is large, diverse and complex,” explains Jessica Robinson, founder of Moxie Future and author of Financial Feminism: A Woman’s Guide to Investing for a Sustainable Future. “And, at the same time, the needs and expectations of clients will vary widely.”
To illustrate the potential for an investor to put their money in an investment that does not reflect their ESG values, Mikkel Bates, regulations manager at FE fundinfo, points to a fund tracking one of the Dow Jones sustainability indices. These invest in best-in-class companies, which can include tobacco firms, mining companies, airlines and car manufacturers. “The firms selected may be looking to make a difference, which will suit some responsible investors, but investing in an oil company is never going to meet the expectations of a traditional ethical investor,” he explains. “Words such as ‘sustainable’ and ‘responsible’ mean different things to different people and, without any consistency, it creates something of a spider’s web for consumers and advisers.”
The number of responsible investment funds is also growing rapidly. As at the end of November 2021, 254 funds were included in the Investment Association’s responsible investment data, up from 199 at the end of 2020.
To address this potential for confusion, regulators are looking at how to create more clarity and transparency around responsible investing. The EU is widely regarded as being at the forefront in this area, especially through its Sustainable Finance Disclosure Regulations (SFDR) and the EU Taxonomy, which creates classifications for ESG activities to enable greater transparency.
Mr Bates says the taxonomy is a particularly hot topic. “It concerns me that there is very little likelihood of a single world taxonomy, as there are just too many differences in opinion over what is and isn’t sustainable, but it’s really helpful to have classifications.”
This need has also been recognised by the Financial Conduct Authority. It has been monitoring the market for responsible investing for several years, releasing a discussion paper, Sustainability Disclosure Requirements and Investment Labels, in November 2021.
The initial consultation closed in early January, with a consultation paper expected in Spring 2022, followed by new rules on disclosure and investment labels. Ryan Medlock, senior investment development manager at Royal London, hopes these will be in place by the end of the year. “It is a good thing,” he says. “I expect it will be very similar to the EU rules but it is an evolving piece.”
Some of the regulatory activity seen in the EU will also influence how the UK moves forward. As an example, Mr Bates says the introduction of three fund categories – under SFDR Article 8 for funds that promote environmental and social characteristics, Article 9 for those with sustainable goals as their objective, and Article 6 for everything else – have influenced behaviours. “There has been a rush on the continent to label funds as Article 8, as this is where investors are putting their money,” he explains. “There is already talk of it being too broad and the need for new categories. The FCA is looking at having more levels.”
While greater transparency may be on the horizon, the current landscape means that advisers can face challenges when meeting their clients’ ESG requirements. Louisiana Salge, senior sustainability specialist at EQ Investors, says it can be difficult. “The best approach, in my view, is to provide the client with some basic education on the different components of sustainable and responsible investing, and then explore their intentions and preferences through a set of open questions and examples,” she says. “This can then be used to propose a suitable portfolio strategy.”
With demand for responsible investing continuing to grow, Mr Medlock says the time is right to prepare for these opportunities. “Adviser firms are at different stages with responsible investing. For those looking to move into this area, I would recommend growing your knowledge, especially around the terminology, and making it part of your conversations with clients,” he says. “Even simple questions such as whether they are interested in getting an electric vehicle or they like to donate to charity can start the conversation.”
There is also plenty of support for advisers wishing to build their expertise in this area, including tools such as FE Analytics and FE Investments Responsibly Managed Portfolios. Professional qualifications are also available from the Chartered Body Alliance, a joint initiative by the Chartered Insurance Institute, the Chartered Banker Institute and the Chartered Institute for Securities and Investment. It recently launched a Certificate in Climate Risk designed for financial services professionals.
Change and new regulations are certainly coming to the responsible investing space, but with appetite for these investments unlikely to wane, it is a market well worth exploring.
Sam Barrett is a freelance journalist