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Andrew Putwain: What are the big trends you're seeing in ESG adoption in the US market?

Gaurav Aggarwal: ESG adoption has gone through a significant uptick in the past couple of years – the number of ETFs and ESG-focused mandates stand testimony to this fact. In addition, a lot of private market asset managers have started adopting ESG metrics and tracking sustainability guidelines. This can either be due to investor pressure or due to ESG becoming a consequential factor in their core investment strategy.

"In the US, while there was initial pushback, we see two categories evolving – one where investment managers want to adopt ESG guidelines predominantly for reporting purposes. The reports are typically mandated by the allocators or investors. Then there is the second category of firms who are adhering to ESG guidelines as an investment strategy as well."

Andrew: Anecdotal evidence from those in the evidence points to the US being more hesitant to adopt ESG principles than in Europe – would you agree, and if so?

Gaurav: Yes. In Europe, funds are taking a more proactive approach in adopting ESG and that correlates well with passive investment inflows in ESG and impact investing-oriented strategies. In the European Union, we saw swift adoption of the Sustainable Finance Disclosures Regulation (SFDR) guideline.

In the US, while there was initial pushback, we see two categories evolving – one where investment managers want to adopt ESG guidelines predominantly for reporting purposes. The reports are typically mandated by the allocators or investors. Then there is the second category of firms who are adhering to ESG guidelines as an investment strategy as well.

When we talk to these firms their main aim is to set up a strategic operational platform to adopt an ESG framework, whether it is in terms of signing up multiple ESG data vendors, adhering to UNPRI or SASB guidelines or leveraging ESG guidelines for proactive risk management and compliance.

Andrew: What operational areas are you seeing funds struggle/excel at with ESG?

Gaurav: The bifurcation between how and why firms want to adopt ESG is critical. Firms that intend to cover ESG for reporting and disclosures primarily would be following either a quarterly or a semi-annual reporting frequency. Still, they would be signing up with multiple ESG data vendors based on the nature of assets they hold. In addition, they would be signing up for the adoption of a materiality framework such as SASB guidelines (laid out by the Sustainability Accounting Standards Board) to ensure appropriate categorisation and segmentation of their assets.

The second category is sets of funds that are tracking ESG as an investment mandate. While they would inherently be coping with all the operational challenges like those in the first category, their additional stress would come from the need to feed ESG factors and scores into the entire portfolio construction and asset allocation process on the front office side. The requirements are multi-fold; from running active compliance and risk management frameworks to driving performance attribution and comparing both allocation and performance with benchmarks. They would like the frequency of evaluations to be a lot more as compared to passive managers.

"One of the alternative execution paradigms for ESG adoption that funds are considering is if they could outsource ESG completely. We have had requests from clients who say that we would like ESG factor analysis and attribution to be provided as a service."

Andrew: Concerns around ESG’s effects on profitability are still raised – do you agree with this and if so, how do you mitigate or justify it?

Gaurav: It is a double-edged sword. Yes, there would be near-term stress on profitability, funds can see if they can put these institutional frameworks around ESG tracking and ESG reporting from an operational risk management standpoint, they would be able to attract a lot more institutional assets across the globe. It’s now part of the core due diligence framework.

One of the alternative execution paradigms for ESG adoption that funds are considering is if they could outsource ESG completely. We have had requests from clients who say that we would like ESG factor analysis and attribution to be provided as a service. That means they do not want to create any internal operational stress, which would lead to more long-term hiring or long-term additional stress on the current operating teams.

"Firms are also signing up with multiple ESG data vendors depending on the nature of the asset class they are trading and also the kind of ESG factors they are interested in tracking."

Andrew: Where do you see fund operators' next big theory around ESG coming from both H2 2022 and next year? 

Gaurav: I see more funds following a particular footprint and aligning to at least one of the standard guidelines (PRI SFDR or SASB) depending upon where their key investor base is.

Firms are also signing up with multiple ESG data vendors depending on the nature of the asset class they are trading and also the kind of ESG factors they are interested in tracking.

Funds producing templates for their ESG investments, which have to be reported on an annual basis as a filing, is also an area to watch out for. We are seeing a whole lot of disclosures popping up from the likes of SFDR and UNPRI to carbon emission templates (CETs/EETs).

 

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