“There’s no question that the topic of sustainable finance is a priority in today’s financial markets and according to Refinitiv Data this bears out in the numbers as well,” opened panel chair Sherry Madera, Chief Industry & Government Affairs Officer at the London Stock Exchange Group, who led the discussion on Day 4: Mandated sustainability reporting: Beast, burden or the only way forward?

Underpinning all of this is materiality – information that markets can trust when a company’s ESG credentials are analysed. Disclosure is all very well but what else can asset managers check? How do they know the company is not just talking the talk but also walking the walk? Context and sector are important, noted the panel.

Regarding decarbonisation, a relatively small number of sectors account for most of the production and consumption of CO₂, reflected State Street Bank and Trust Company’s Global Head of ESG Richard Lacaille. So, while net zero commitments are not yet universal, the big question is whether those we do have are in “areas that are material in terms of CO₂ production,” he added. When it comes to financial materiality, Lacaille said that asset managers are guided by independent institutions such as the Sustainability Accounting Standards Board (SASB)³ and the Resolution Foundation⁴ that help inform what matters in specific industries. “In some cases, this will be carbon but in others material ESG issues. We need to ensure investors get good long-term returns, so must therefore pay attention when making decisions to the things that influence very long-term cash flows of the companies we invest in or the credits we are supporting.”

Of course, the issue of sustainability has both a political and social dimension but accessing evidence is hard for those making decisions in the asset management or banking business. Lacaille reminded delegates that financial decisions from investors and lenders are “long-term in magnitude” so the data quality that informs them is critical to delivering “better long-term outcomes to savers and investors.”

The panel agreed that relevant and robust metrics are vital. ESG transition requires transaction models, product solutions and regulatory measures which meet international standards. In addition, said Kamran Khan, Head of ESG for APAC at Deutsche Bank, “Buy side needs for data are significantly different from what is happening on the sell side. If I am on the buy side, I am buying data so that I can make smart investment decisions whatever my integration philosophy might be. If I am on the sell side, I am advising a client to make themselves more credible as an ESG compliant company.”

“The metric you choose must be credible”
Kamran Khan, Head of ESG for APAC, Deutsche Bank

He went on to explain how the ESG Centre of Excellence in Singapore launched by the bank in May 2021 in partnership with the Monetary Authority of Singapore (MAS) makes it possible to satisfy both sides by originating brand new data and coming up with new KPIs not used in that vertical globally. Systems were put in place for the clients to report their data quarterly.

Khan pointed out that “there is a lot of guidance,” including not only the EU Taxonomy, but the Sustainability Accounting Standards Board (SASB), International Finance Corporation,⁵ World Bank,⁶ and the UN.⁷ His team assesses the entire scope to see what the guidance is that affects a particular company in that business. “The metric you choose must be credible so that when a third party looks at it, they know you are measuring the right things and it should be achievable.”

As the metrics requires a very deep understanding of the client business, Khan prefers disclosure sources to be from corporates, because then “investors can make smart decisions and be held accountable for using or not using that information and they can assess whether your integration model is real or soft.”

Another reality check comes from each economy having its own views on how much disclosure it can ask for without scaring business and investment away. In Asia, “even regulators have to balance public interest and a country’s competitive strategy in that region,” he reflected. If requirements are too tough, companies will simply move their hubs to a more accommodating jurisdiction. But if they are too soft, people do not believe the country is serious enough about ESG so is therefore not the right place to do meaningful benchmarking.

The financial industry needs, said Madera “to continue the pressure of being more granular” and get beyond the basic questions such as “Do you have a water policy?”. From 10 March 2021, the EU’s Sustainable Finance Disclosure Regulation (SFDR) required asset managers and other financial market participants to provide (to quote the KPMG snapshot⁸) “prescript and standardised disclosures on how ESG factors are integrated at both an entity and product level”. But this rule does not apply to corporates.

Commerzbank’s Head of Risk and Resource Steering Martin Seimetz agreed that each jurisdiction has different challenges, and this puts regulators and players in the market into different positions. He regards the financial industry as at the start of a journey where joined-up regulation is just beginning. Another issue, he reflected is that regulators like to be as progressive as possible, but this introduces complexity – making it difficult for the smaller companies to implement new measures.

In Germany, he added regulators are issuing the German Supply Chain Duty of Care Act which comes into force in January 2023. The Act, said Seimetz, will have a cascading effect as it requires companies to beef up their transparency and show within their industry what supply paths they will take – something that will be shared with financing companies. He developed a point made by other panellists that “digitalisation is a means to success.” In other words, enlightened corporates are building out their core financial systems to integrate ESG data. This way, reporting will improve and will help financial market decision-making.

Citigroup Global Markets’ Seelig addressed the question raised earlier in the discussion by lenders and asset managers, “Do our firms have a plan achieving net zero and sustainability targets?” She then shared how Citi’s team had undertaken a project with a regulator looking at climate risk in their balance sheet and trading books for one of the legal vehicles. “It’s really complicated,” she admitted. “You need to bring together climate science with climate economics with that financial materiality and play it forward to understand the impacts on credit insurance, commodity prices, and so on.”

“Regulated disclosures are fact-based and that is why then can be audited”
Richard Lacaille, Global Head of ESG State Street Bank and Trust Company

The difficulty with sustainability risk arises in the opacity of how market participants see and price it, continued Seelig. With the playing field far from level, panellists did agree that regulators need to “step in and help us get the disclosure we need” when it comes to forward-looking scenarios. Madera observed that when using data to assess future risk with scenario planning, participants need to grapple with extrapolation, estimation and error (“the three Es). In other words, how do you deal with uncertainty?

“Investors have also had to look forward,” reflected State Street’s Lacaille. “They have not always had data, and much investment is quite qualitative and involves judgements about a lot of different information which may not be as hard as data. Regulated disclosures are fact-based and that is why then can be audited.” He explained that forward-looking statements might be in the management commentary but have a different status. However, that forward-looking information – especially as it relates to climate and decarbonisation plans – is “particularly important.” In other words, the most important thing an asset manager is looking for is unlikely to be regulated or disclosed in a regulated fashion.

So, what can an asset manager turn to? A strong, independent and credible board who oversees disclosures is particularly important to investors running concentrated portfolios. “We are going to grapple with how much you make mandatory, how political you make mandatory disclosures become and what investors do about encouraging voluntary arrangements, but which I think in some ways are much more likely to be successful,” concluded Lacaille.

As the session wrapped up, it fell to Deutsche Bank’s Khan to connect ESG with value and return. “We are just getting into ESG as a risk management tool,” he said. “If we all believe ESG is going to permeate every aspect of the financial services industry, we must anticipate that at some point people will be adding value to the ESG part. It cannot just be PR or CSR. It needs to be associated with material financial return implications.”

Sources

¹ See https://refini.tv/3CmTwSK at refinitiv.com
² See https://bit.ly/3Eivkld at un.org
³ See https://www.sasb.org/ 
⁴ See https://www.resolutionfoundation.org/ 
⁵ See https://bit.ly/3nBTBf8 at ifc.org
⁶ See https://bit.ly/3nxFIPg at worldbank.org
⁷ See https://bit.ly/3Ckz3xT at unfccc.int
⁸ See https://bit.ly/3BlrPIX at assets.kpmg