ESG investing: Three risks to consider

The continued popularity of funds with an environmental, social and governance (ESG) focus has put global ESG assets on track to exceed $53tn by 2025, up from nearly $38tn at the end of 20201.  

As growth continues, expectations for effective compliance policies and controls in place are expected to become more rigorous as political and regulatory regimes come under pressure to protect investors. So, what areas of scrutiny can asset managers and advisers expect? Certainly, asset managers should ensure that they can substantiate their claims about ESG investing and that the impact is appropriately measured, evaluated, and adjusted when required. 

Asset managers will also need to demonstrate they have the appropriate systems, processes, and controls to ensure that compliance programmes and investments are consistent with their stated ESG strategy. Three risk areas to consider include:

#1 Portfolio management

Ensure portfolio management is consistent with disclosures about ESG approaches. Controls in place should clearly maintain, monitor, and update clients’ ESG-related investing guidelines, mandates, and restrictions. 

Sufficient controls to ensure that the investments can be monitored and screened as advertised and that controls are precise enough to provide the required level of oversight will be essential. In addition, managers should take care to review their approach and reconcile it against their actual proxy voting policies and practices.

#2 Performance advertising and marketing

While not unique to ESG investing, managers should always ensure that disclosures surrounding investment approaches are transparent and provide clients with any disclosures on conflicts of interest. Managers should also substantiate their internal approach to ESG investing, including explanations for any investments that indicate “style-drift”. 

Controls should ensure that ESG-related disclosures and marketing are consistent with the firm’s practices and that the marketing information matches the actual processes. It’s also essential to assess how changes in processes or marketing strategies are addressed via the controls and whether they are precise enough to provide the required level of oversight.

#3 Compliance programmes

Managers should develop specific compliance programmes to ensure that the firm appropriately addresses the risks of non-compliance applicable to their ESG investment strategy and approach. Additionally, ensure that compliance personnel are knowledgeable about the firms’ specific ESG-related practices.

As the ESG investment sector continues to grow, closing the gap between how ESG investments are advertised versus the reality of the investment philosophy and management will be essential. As the sector comes under further scrutiny from global regulators, asset managers would do well to heed the advice of famed psychologist Carl Jung, who once said, “you are what you do, not what you say you’ll do.”