ESG Regulation - "Don't wait, act now!"

James Dalby, ESG Lead at Aviva Wealth, shares his thoughts on ESG regulatory developments, and his top tips to help you get ahead of the curve.

We’re heading towards one of the most interesting sets of FCA rules we’ve seen in recent years.

Long gone are the days where we wondered whether the UK would adopt the European Union’s (EU) existing Sustainable Finance Disclosure Regulation (SFDR); HM Treasury instead decided it would use Brexit freedoms to create something that was a better fit for the UK. The Government’s overall approach to sustainable investing was set out in October, through a paper – Greening Finance: A Roadmap to Sustainable Investing.

It included references to the much-discussed topic of Sustainable Disclosure Requirements (SDR) and investment labels, as detailed in the FCA’s Discussion Paper (DP) 21/4. A consultation paper will follow, published later this year.

Whilst this doesn’t mean the UK will see something completely different from the EU’s proposals (which will be a relief for fund providers distributing funds across both the UK and Europe), it does mean the UK will be able to learn from the challenges the EU has had with SFDR.

FCA engagement with all stakeholders on this topic has been excellent – both at customer and industry levels. This gives me confidence that the UK regulator is seeking all voices in the chain.

In terms of size and scale of the regulatory change, I believe it will be at least a big as MiFID II, though it’s fair to say that the product and fund scope is much wider than MiFID II. Most firms will definitely need a well-structured and resourced change programme/project.

Existing market

Whilst the regulatory environment is taking shape, there is a very active investment fund market where ESG credentials are already playing out in sales and marketing activity. In reality, what I would have traditionally viewed as ‘ESG-specific’ funds have actually been available for decades – Aviva itself is the proud provider of the Stewardship-range, which started with the UK’s first ethical fund range in 1984.

There are also many financial advisers (FAs) who have specialised in ethical investments, a forerunner of the ESG universe. And, increasingly, wider groups of FAs are talking to their clients about ESG themes.

I have used ESG as an all-encompassing term (capturing Sustainable, Ethical, Impact, Green, Responsible etc) – I’ll let SDR and investment labelling help us towards a standard lexicon in the UK, one of the great opportunities the FCA’s work can address.

It’s worth saying now that as ESG is such a broad and deep topic, to simply label a fund ESG or not would miss this point.

I think we need to quickly move to a mindset where the question is, “What are a fund’s ESG credentials?” Most funds can claim (and if not today, they will in future) some ESG points – the difference is the type, depth, and breadth of those credentials.

There are already ESG fund ratings providers which can rate all funds, whether the funds hold out to have strong ESG credentials or not. For example, MSCI has its ESG fund ratings, with a scale that ranges from AAA to CCC. Morningstar also has a fund ratings solution with its sustainability rating, which operates on a scale of 1-5.

I believe independent ESG ratings such as these will still continue to be available and add value alongside the regulatory approach. For example, if the FCA introduces a range of buckets to subdivide the ESG universe, within those buckets individual funds could still be given independent broad-based ESG ratings. This would be similar to the way funds are already assigned a sector categorisation and subject to various different quantitative and qualitative fund ratings.  

Of course, one of the most significant and growing parts of the UK investment landscape is the DFM Managed Portfolio Service (MPS) market. How the FCA labels will apply to such propositions is, in my view, one of the biggest challenges. Yes, each individual fund in a portfolio will have a label, but the customer will typically look at the top-level portfolios, where creating a single label will be difficult. One solution might be to ask the DFM MPS providers to self-declare which label is appropriate for the aggregated portfolio, but this won’t be as easy as it will be for a fund-of-funds model. Lots of debate is needed and I expect the FCA will welcome a range of proposals.

Taking action now

For FAs who are waiting for regulation to land, my key message is – don’t wait and do act now!

Recent comments from the FCA, at a Square Mile Responsible Pathway event (25th January 2022), help to underline why:

"In many respects, ESG is already in scope when advisers give investment advice. Under existing rules, firms have to act in a client’s best interest and collect all necessary information to understand the client’s investment objectives. In that context, suitability, within our conduct of business rules, already requires the consideration of ESG preferences. The rules set out the objectives that a firm is required to consider but this is not intended to be an exhaustive list."

So, my tips would be:

-        Have a read of both the Greening Finance and SDR papers

-        Ask your fund and platform providers if they already provide any ESG-related data and support

-        Think about how you do or will speak to clients about ESG

These relatively simple steps will put you ahead of the curve and make it easier for you to adapt to regulatory developments as and when they arrive.

James Dalby, ESG Lead, Aviva Wealth

James Dalby has over 25 years’ experience in investments and has worked at Aviva for 16 years.

Aviva's ESG profiling tool, which is available on the retail adviser platform, provides an independently verifiable assessment of a client's holdings against a range of ESG preferences.