In 2020 there are numerous unanswered questions: Covid-19, how did it happen? Will there be a vaccine? Did Donald Trump really say that? However, there is one question which a number of advisers are now focusing on: What does ESG (environmental, social & governance) mean for my business? 
There is growing awareness within the adviser community of the impending potential changes to the ‘suitability‘ requirements covered by the amendment of Article 25 of MiFID II, Delegated Regulations Articles 2, 52 and 54. This has implications for the provision of investment advice and suitability with the proposed legislation requiring an adviser to identify a client’s ESG preferences.
This is easier said than done. There is now an EU taxonomy to assist this process, which has a heavy environmental bias to its guidance on preferences, but even with this now published, there is still no real clarity and no published timetable for the introduction of these changes. To cloud the issue further, there is even the suggestion that the UK government may delay its pledge to incorporate this set of amendments which could remove the issue entirely.
However, even with all this confusion, there is an undoubted societal shift at play where the desire from investors to do good and avoid harm has moved from niche to mainstream. The evidence is there for all to see with fund flows. Responsible funds are leading the sales charts, the coverage of responsible funds in the media has increased and there have been a significant number of new fund launches in this area. There is definite momentum and the adviser market needs to consider how to incorporate this change in attitudes to ESG and Responsible investment into their processes.
The chart below may provide a useful starting point. It begins with the fact find and here I think it is important to help the client to determine what their financial and non-financial objectives are. This latter point has often been ignored or overlooked and now needs exploring, identifying and recording if an adviser is to stay compliant.
The discussion around non-financial objectives involves identifying what is important to the client and may highlight some specific requirements to help structure their investments. These might include taking account of certain exclusions such as tobacco or investing in companies which have a positive impact on the environment. These objectives can then be translated into known investment strategies.
The subject of ESG is slightly more problematic. In its purest sense, ESG is a risk framework with which to identify issues that may impact the value of a security. When discussing the non-financial objectives with a client, advisers will have identified if they wish their investments to reference this and a fund with ESG integrated into its process will provide a baseline for consideration.
The choice is then whether this matters to the client or not. If it is the latter, they can follow an established process for identifying an appropriate risk-based solution. For those clients who do wish to have some consideration of doing good in their investment solution, there needs to a be secondary question: are their preferences explicit and personal? If so, there needs to be a more bespoke solution. As the diagram illustrates, the nature of that solution and how tailored it is will then depend on the value of the funds to be invested.
For those clients whose preferences are broader, a set of models which have a robust methodology of taking account of a fund’s ESG preferences may provide an ideal solution.
The question then becomes where an adviser can find a reputable data set on funds and asset management companies, indicating where they are in terms of ESG integration.
Square Mile has developed such a database with ESG integration assessments housed within the Fund Dashboard, which was developed along with FE fundinfo. It shows key information in a simple visual format, with one section dedicated to showing ESG assessments, on a fund by fund basis. The assessments provide reference points between 0 and 3, with a score of 3 being awarded to funds or asset managers where ESG is fully integrated and instrumental in security selection. The Fund Dashboard is available on a broad spectrum of funds covering passive, active, income and multi-asset/risk-targeted. These assessments provide an option to build either a range of portfolios utilising the highest assessed funds or a panel from which to offer bespoke solutions to clients.
The Fund Dashboard may just be the means to help you answer this currently unanswered question.
Steve Kenny is commercial director at Square Mile Investment Consulting and Research. The views expressed above are his own and should not be taken as investment advice.