Meeting the ESG challenge
ESG is an increasingly important topic in finance and a source of concern for both asset managers and investors. Although it is not a new topic, the trend is now accelerating, as demonstrated by the introduction of the SFDR and the proliferation of funds adhering to clearly identified and labelled strategies.
To better understand these changes and to better support its clients, in addition to its regular contact with them, Societe Generale Securities Services (SGSS) conducted a series of interviews at the beginning of 2021 with around 30 buy-side players and several consultants from major financial centres in Continental Europe1.
This poll was aimed at managers of funds subject to UCITS2 directives and at actors in alternative or private markets as well as institutional investors. The results confirm client sentiment and point to an inescapable upheaval in the financial world, while also highlighting the challenges we are all going to face.
The first observation we can make is that virtually everyone has already incorporated multiple sustainable investment criteria into their strategies. This first point further proves, if proof were still needed, that the regulatory objective of encouraging stakeholders to integrate ESG3 criteria into the various management policies has been heard loud and clear.
However, the strategic choices of asset managers go well beyond this and are also accompanied by growing investor awareness of the need to integrate sustainability criteria into their investments, thus following the trend across society more generally. We are seeing a proliferation of funds classified as Article 84 or Article 95 within the meaning of the SFDR6, which, depending on the market, affects nearly one-third of the assets under management. It should be noted that these figures continue to increase.
Despite this, the challenge of integrating quality ESG data into managers' operating processes is complex. Data has become key to ensuring the success of this transition. While there are currently ESG data providers for UCITS funds (with special considerations by theme, type of security or geographic region), they are not always viewed or considered by managers as reliable and irrefutable with regards to the chosen ESG strategy. This situation makes it difficult, if not impossible, to obtain a reliable calculation or classification of their investment funds according to such criteria.
Furthermore, there are no established rules for compiling these extra-financial criteria. In the absence of standardisation or the emergence of widespread practices, this is forcing management companies to manage the algorithms used to calculate their extra-financial performance.
So there is a lack of both reliable data and established calculation rules, although no lack of available technical solutions. For example, when SGSS, as part of its "front-to-back" solution, gives managers the option to include ESG rules in pre-trade controls, they are still reluctant to implement them. They fear that their transactions will be blocked due to a lack of extra-financial information which is difficult to confirm. This situation forces asset managers to opt for ex-post treatments rather than an ex-ante solution, which could restrict management decisions.
If, as we have seen for UCITS funds, data can be an obstacle to the widespread implementation of ESG, the situation is even more problematic for alternative funds. This is because those funds must deal with a virtual absence of data. Client companies must therefore become data collectors. To do this work, asset managers are forced to directly contact auditors, technical research departments and management of the investee structures ‒ which is not their core business ‒ and they often come up against a lack of tools to record and compare that data.
In summary, the overall trend in the market indicates that while ESG is clearly on the 2022 agenda for asset managers, taking sustainable investment criteria into account is still a challenge for many of them. This shows the fragility of an operating model that is sometimes pushed to its very limits.
This is where the challenge lies for service providers such as SGSS: to develop and propose ESG solutions that make asset managers' lives easier by enabling them to focus on their core business, which is choosing the right investments. That is why integrating ESG data into the Portfolio Management System, and more broadly into all control and middle office processing, is a key issue in the product development strategy of banks and securities services.
However, the lack of uniformity and the difficulties in obtaining the data mentioned above are now an obstacle that players in the sector will have to overcome. Beyond regulations, we will have to move from merely staging, from marketing labels, to normalised evidence of such strategies. This normalisation phase will need to involve a significant harmonisation of source data, as well as the standardisation of calculation algorithms and "green" regulatory reporting. This will allow each manager to compare their ESG strategy and outcomes with those of their peers. This is what investors expect and this is probably what the regulatory authority intended in drafting the SFDR.
This is the challenge SGSS is tackling today with its clients: integrating ESG data into all of the bank's business processes, from pre-trade controls to valuation calculations and depositary controls. Because of the factors mentioned above, no one has yet reached this ultimate goal, yet this quest is now essential for anyone wishing to support asset managers in what could truly be a new dynamic in the market and one that transforms it in a lasting way.
While ESG is an increasingly important issue in finance, its implementation will remain a key focus on the transformation agenda of asset managers, banks and investors in the coming months and years.
By Guillaume Roch, Head of Business Development, Societe Generale Luxembourg
Article published in March 2022 in AGEFI Luxembourg. Online edition available in French here.
1 https: //www.securities-services.societegenerale.com/en/insights/views/news/sustainable-investment-history-the-move/
2 UCITS: ndertakings for collective investment in transferable securities
3 ESG: Environmental, Social and Governance criteria taken into account to measure the integration of sustainable development issues within companies.
4 Article 8: funds highlighting ESG criteria in their investment strategies
5 Article 9: funds with a sustainable development objective
6 SFDR: Sustainable Finance Disclosure Regulation, a new regulation requiring management companies to produce reports by fund on the integration of sustainable development criteria into their investment strategies