Written evidence submitted by Ruffer LLP – (DUE 0094)

 

 

 

Rt Hon Nicky Morgan MP

The Treasury Select Committee

Westminster

London

SW1A 0AA

 

 

 

 

Dear Ms Morgan

 

Please find attached our response to the Decarbonisation of the UK Economy and Green Finance Inquiry

Introduction

 

Ruffer LLP offers discretionary investment management and at present has £20.6 billion assets under management. We are authorised and regulated by the Financial Conduct Authority. Ruffer LLP is a limited liability partnership (LLP) owned by current and former members of staff. This structure aligns our interests with those of our clients by emphasising investment returns and client relationships that are sustainable over the long term.

 

For a practical summary of how Ruffer LLP integrates responsible investing into its investment approach and how it carries out its role in stewardship on behalf of clients please see Annex 1 to this letter.

 

Should you wish to have further information or clarifications on our response, please do not hesitate to get in touch with me.

 

 

Victoria Powell

Regulatory Policy Director

 


Annex I: Summary of Ruffer LLPs approach to Responsible Investment

At Ruffer we interpret responsible investment as the incorporation of environmental, social and corporate governance (ESG) considerations into our research and investment processes - while behaving as active stewards of our clients’ assets. We recognise that ESG considerations are important drivers of investment performance, representing both sources of value and investment risks. Therefore, incorporating these considerations into our investment approach forms an essential part of our responsibility to our clients. We believe that investing responsibly will lead to better long-term outcomes for our clients. Ruffer became a signatory to the Principles for Responsible Investment (PRI) in January 2016 in order to strengthen our commitment to integrating ESG into our investment approach.

Integration

As an absolute return manager with a relatively concentrated portfolio of equity holdings, we endeavour to fully understand a company’s risks and opportunities, including relevant ESG considerations. As we have one investment approach and conduct our own research, we are able to systematically integrate these considerations across our research and investment processes. Our decision to invest in companies is therefore based on both rigorous analysis of the fundamentals of companies and ESG analysis. This also informs our stewardship activities, including engagement and voting. Our specialist responsible investment team partners closely with the analysts in our research team to identify and evaluate the material risks and impacts to the environment and society that could arise as a result of a company’s operations. The risks associated with weak corporate governance practices are also considered. We use MSCI ESG Research and other relevant sources, such as the Sustainability Accounting Standards Board (SASB), Transition Pathway Initiative (TPI) and CDP to inform our analysis. Our responsible investment team participates in weekly research team meetings where new stock ideas are discussed. ESG considerations are then raised at stock reviews within the research team and with portfolio managers. These considerations are not only important in company analysis but also in macroeconomic analysis, and hence issues such as water scarcity, energy and climate change are discussed routinely. We provide ESG training to our research and portfolio management teams frequently.

Stewardship

At Ruffer, we endorse the Financial Reporting Council’s definition of stewardship in its proposed revision of the Stewardship Code as ‘... the responsible allocation and management of capital across the institutional investment community to create sustainable value for beneficiaries, the economy and society.’ To act as responsible stewards of our clients’ assets, we use our professional judgement to determine when to engage and how to vote at shareholder meetings to best protect the economic interest of our clients while being cognisant of the impact on all stakeholders. Ruffer has supported the UK stewardship code since 2012 and our statement on the code is available on our website. In 2016, the Financial Reporting Council (FRC) categorised the stewardship code responses into three tiers. Ruffer’s response was assessed as tier 1; meaning ‘signatories provide a good quality and transparent description of their approach to stewardship and explanations of an alternative approach where necessary.’ In August 2015, we became a signatory to the Japan stewardship code as we felt it was aligned with the UK stewardship code.

Engagement

Ruffer believes that engagement is an effective tool to achieve meaningful change and we are committed to engaging with companies in which our clients’ assets are invested on a wide range of topics. Engagement gives us an opportunity to improve our understanding of investee companies, which enhances our investment decisions. By engaging with a company to achieve specific goals, we are improving our understanding of the material ESG risks it faces, challenging its behaviour in relation to ESG considerations and in turn increasing its awareness of regulatory and societal changes. This is likely to result in superior outcomes and returns for our clients. We will engage on our own, or with other investors that share our concerns through collaborative initiatives such as Climate Action 100+, which was launched in December 2017 and to which Ruffer was a founding investor signatory. Collaborative engagement can also provide a platform to engage on wider sector, regulatory and policy matters with investors and other stakeholders. Ruffer is open to working alongside other investors on both policy and company specific matters. The decision to collaborate on company specific matters will be judged on a case-by-case basis by the responsible investment team with input from research analysts and portfolio managers as well as the legal and compliance teams. Ruffer engages regularly with the Investment Association and the Institutional Investor Group on Climate Change (IIGCC). Through our commitment to Climate Action 100+ we have collaborated extensively with other investors and asset owners to engage with a number of European and American companies, including making statements at Annual General Meetings (AGMs) and co-filing shareholder resolutions.

Voting

We take the opportunity to vote seriously, as it enables us to encourage boards and management teams to consider and address areas that we are concerned about. It is Ruffer’s policy to vote on Annual General Meeting (AGM) and Extraordinary General Meeting (EGM) resolutions, including shareholder resolutions, as well as corporate actions. We apply this policy to both domestic and international shares, reflecting the global nature of our investment approach. We endeavour to vote on the vast majority of our holdings but we retain discretion to not vote when it is in our clients’ best interests (for example in markets where share blocking applies). For our flagship funds, it is our policy to vote on all holdings. Research analysts, supported by our responsible investment team, review the relevant issues on a case-by-case basis and exercise their judgement, based upon their in-depth knowledge of the company. We have internal voting guidelines as well as access to proxy voting research, currently from Institutional Shareholder Services (ISS), to assist the analysts in their assessment of resolutions and the identification of contentious issues. Although we are aware of proxy advisers’ voting recommendations, we do not delegate or outsource our stewardship activities when deciding how to vote on our clients’ shares.


Written Evidence submitted by Ruffer LLP to the Decarbonisation of the UK Economy and Green Finance Inquiry

Executive Summary

 

The economic opportunity

What economic costs and benefits does decarbonisation present for the UK?

 

  1. Full decarbonisation entails dramatic changes in the use of energy and land as well as our trade strategy (particularly, with non-decarbonised economies). For example, in relation to our trade strategy, we will need to assess the impact of our policies to decarbonise on national industry and how this may impact international trade. The EU for example, is currently considering adjusting for carbon costs at the border to prevent the relocation of carbon-intensive production to non-EU countries – a problem known as ‘carbon leakage’. Should these products be sourced in countries that do not apply these strategies, Europe will face short term losses to national industries as they become internationally uncompetitive. In the longer term however, Europe may also face further severe secondary consequences of non-decarbonised economies affected by the repercussion of climate change in the form of mass migration resulting from economic instability and potentially wars. Nevertheless, there are moral and practical challenges to this approach as well, which should not be underestimated and careful thought needs to be given as to how we encourage decarbonisation nationally in our industries whilst, also avoiding importing the same practices.
  2. The required structural change to the UK economy from decarbonisation is immense. Entire new economic sectors could be created and some currently important economic sectors, such as gas and oil may decline severely. The new economic sectors are likely to require different skills, which means workers in the declining sectors will need re-training so they can gain from the new jobs created.
  3. In the past, the UK has experienced similar changes in a limited but very significant sense with severe dislocations of industries regionally. Examples of this include the end of mining or ship building. Previously, these were generally felt geographically within specific communities. These changes had severe societal implications and resulting in lost generations of workers and economic communities. The success of a transition and the ability of governments to follow policies through for decarbonisation, would be severely undermined if the changes are not managed in such a way that society does not buckle under the implications.
  4. We should be mindful that the changes decarbonisation brings about could be considered of even greater and more widespread consequence than those faced hitherto and therefore, careful cross-governmental planning is required. We would question whether the traditional structure of government departments can deliver the necessary holistic strategy and we would suggest more thought should be given as to how government could best organise itself to plan for such a significant intervention. We would also argue that greater consideration needs to be given as to how to avoid the negative consequences of a four year political cycle which could undermine the planning of such a long-term strategy, given that this requires significant investment by firms who will require certainty to effect these investment plans.

  1. De-carbonisation could bring co-benefits – making housing more efficient improves climate mitigation and is a way of adapting to future issues of climate change; transport changes could result in improvement in air pollution with health benefits for society; the avoidance of soil erosion from climate change will diminish the increased need for fertilisers leading to greater carbonisation. The decarbonisation costs could also be seen as investments that will deliver a return in the future and this will be felt both societally and economically. It will be important to ensure these investments are well thought-through and communicated to the public so that less obvious or evident benefits are also drawn to their attention to maintain continued support. It will be critical for all citizens to feel that this progress is being lead with a clear purpose and vision and that the need to address social injustices that might arise or have previously arisen, are central to thinking in how best to bring these changes about for the long-term benefit of all.

What benefits can a growth of the Green Finance sector deliver for the UK, and does the UK hold a competitive advantage in this space?

 

  1. The strength of the UK as a financial services global hub, post Brexit, cannot be taken for granted. However, we would agree that a Green Finance Strategy which positions UK financial services as an expert could help bolster our competitiveness and counter the tendency to lose out to other international financial centres. This would suggest however that we must continue to align and ensure the standards in this area are ‘best in class’, but crucially, that they remain internationally compatible. For example we would need to be able to support other national reporting standards in an easily translatable format whilst avoiding too much complexity. This also means that industry business standards should be aligned with international conventions on climate. This too would increase investment inwardly into UK companies and further allow the UK financial sector to understand the risks of firms they invest in better, thus creating a virtuous cycle. We have already experienced that other geographic regions (eg Japan) are interested in developing similar action plans to the EU and have come to us at Ruffer to gain a greater understanding of what it entails. We must remain as being seen as experts, even post Brexit, on how ‘best in class’ policy making and implementation is developing in this area.
  2. The UK currently has several bodies strategising on the implementation of a green finance plan, such as Department for Work and Pensions (DWP), the Financial Conduct Authority and Bank of England (FCA/ BoE); Financial Reporting Council (FRC) and the Green Finance initiative. Nevertheless we would suggest that there might need to be a more centralised intergovernmental body that takes expertise from national departments to deliver a more holistic national and international response. This body might also be a ‘centre of excellence’ that other government departments can draw on and can align their own policy-making with, as well as ensuring thoughtful implementation of centrally-agreed policy.
  3. This body should be broader in focus than simply finance, although this would be a crucial element. It should also consider social and regional impacts, as well as the consequences of international trade. Long term planning and channelling of political ambition into clear actions is most successfully done when it is supported by the strategic capacity of Whitehall, as evidenced by previous bodies such as the Prime Minister’s Strategy Unit (PMSU) or the Social Exclusion Unit.
  4. Ruffer LLP became a signatory to the Just Transition which considers the social aspects of a transition to a low carbon economy. These initiatives are crucial to gain social approval for the changes taking place and this declaration seeks to address the potential of huge economic dislocations that take generations to remedy. The UK has signed up to the Just Transition as part of its commitment to the Paris Agreement. Nevertheless, we would suggest that greater prioritisation by government be given to the integration of the Just Transition approach in shaping national policy, in particular policy regarding international trade and aid. This priority should be given higher profile publically, amongst all societal stakeholders, such as investors, civil society, social partners, companies etc. to ensure it is implemented more effectively. This includes the need to provide all stakeholders with greater understanding on how to translate this effectively into their activities; and how best to report on their impact. It would also be beneficial to ensure clearer objective-setting and reporting by government on policies they develop and implement.

How might HMT deliver a regionally balanced and ‘just’ transition across the UK?

 

  1. As expressed earlier, we would strongly urge that we learn from mistakes in earlier industrial changes that have resulted in deskilling of communities which were poorly managed.
  2. We would urge a three-pronged approach involving government, companies and communities/consumers; these three work streams’ strategies would interact with each other and their approach and plans could evolve in response to this interaction.
  3. To be successful, we would argue that it must be well-managed and introduce a phased approach which is thoughtfully considered and mapped across economic activities. In order to do so, this will require the development of cross departmental strategies which addresses regional impacts and opportunities. We would also strongly urge that it positively engages all industry – even industry which is currently considered to undertake brown activities - so that companies are actively engaged with policy-makers in the necessary shifts required to make this transition for the UK economy. Any improvements in their activities should be strongly encouraged and the issues that might face each industry, according to its activities in the future, should be tackled directly in order to demonstrate leadership and build confidence of citizens and consumers impacted by difficult decisions. Any such programme should also address education and training for the new economy, both regionally and nationally. It must be an ambitious plan but crucially, there must be certainty for industry to make the necessary investments over time.
  4.                                                                     The plan should be specific to company activities and seek to encourage them to move along the continuum from wherever they are currently positioned. Companies would need to set a challenging objectives, and establish where they stand according to each activity and how they will practically progress their investments and the necessary adaptations (including training for their staff) to move them closer towards an ultimate objective that will stretch them. These plans could then be updated as progress is made and assessed. Effective companies would be encouraged to do this planning in consultation with staff and stakeholders, such as investors and consumers. This would increase legitimacy and increase pride and loyalty amongst staff, consumers and investors. Ultimately, this process (if effectively undertaken) could provide an opportunity to restore confidence in capitalism and empower effective citizen engagement.

  1.                                                                     As highlighted earlier, we would urge that the focus should not only be on green activities alone, but should seek to move all companies and sectors along the continuum from wherever they currently stand, in a series of phases that are sufficiently progressive to build momentum and that are sufficiently measurable as to report on. In turn, investors could use this in their stewardship activities. The mapping of these activities could also be assessed regionally to anticipate the extent of impacts and reviewed against opportunities and possible investment incentives by government departments which could then adapt policy incentives to support the path to transition.

HMT’s strategy

How does HMT work with the Clean Growth Strategy and government departments to support decarbonisation? Is this working well?

 

  1. We welcome the Clean Growth Strategy (CGS) and the signal that it made in its objective to grow national income and productivity whilst cutting green-house gas emissions. The inclusion of an ‘emissions reduction plan’ evidenced the challenge that firms would also face in setting an ambitious target when changes in society and technology are unknown. Additionally the introduction of the Emissions Intensity Ratio (EIR) which is used to “measure out clean growth performance” has illustrated the challenge faced in accurate and clear statistics. Nevertheless, the fact that the EIR has decreased by approximately 4.3% per annum since 2016, at least shows progress in the right direction, even if the results should be treated with caution.

How should HMT’s approach evolve to ensure the Government meets the legally binding carbon budgets (and the net-zero targets, if applicable) 

 

  1. As indicated in response to earlier questions, we think HMT’s strategy should evolve and respond to a broader UK strategy which needs to reflect carefully the impact these changes will have on society as a whole. It should seek to integrate international developments in any changes to the regulatory framework it oversees, in order to ensure we remain attractive internationally as a centre of expertise.

What role should the 2019 Comprehensive Spending Review play in UK decarbonisation? What projects or measures should receive additional funds through this process?

 

  1. The Treasury plays a central role in enabling effective policy implementation. Given that it establishes the tone of government expenditure over the next three years, including any departmental restructuring. It provides a crucial opportunity to indicate how decarbonisation will sit alongside the priorities created as a result of Brexit. Given the urgency of decarbonisation, it should factor in every spending decision in every government department and must avoid the risk of being hijacked by short-term significant ‘events’.

Green Finance

What role do UK financial services firms currently play in the decarbonisation of the economy, (for example, through stewardship, capital allocation to green projects, green financial products)? What more can they do?

 

  1. Financial services firms currently influence decarbonisation through different sets of activities:

-          capital allocation to climate-related investment themes (climate mitigation and adaptation, water scarcity, technology disruption and energy transition);

-          individual stewardship (engagement and voting with investee companies);

-          collaborative stewardship (engagement with a wider group of financial services firms and asset owners, e.g. Climate Action 100+):Effective stewardship is very reliant on long term engagement, however, the holding of the assets is not always aligned with the duration of the engagement necessary to see the results and this is still the case for pension funds whose strategy by nature is long term; Or, even for Ruffer LLP, despite our ‘absolute return approach’ which is also comparatively long-term in nature. Despite this, the length of holding can be affected by the cycle in the market or conviction in the company. We have therefore found that the best way to manage this challenge, but remain active, is it to undertake collaborative stewardship through Climate Action 100+ which we joined as a founding member in 2017;

-          through industry bodies such as the Institutional Investor Group on Climate Change (IIGCC);

-          by disclosing their stewardship and investment activities in line with the Financial Stability’s Taskforce for climate related financial disclosure (TCFD).

 

  1. We believe labelling of ‘best in class’ approaches (that can be assessed or evidenced) would be helpful in encouraging decarbonisation and generally avoiding ‘green washing’ which could have a detrimental impact on client trust and which ultimately undermines good industry practice and investment by financial services firms.
  2. We believe labelling along the lines of investment approaches that incorporate good practice would also be more aligned with encouraging an evolution within industry sectors, ensuring we actively engage with companies on the transition pathway. This approach to labelling avoids risks to our clients’ financial assets. For example, through stranded assets or other climate-related financial risks. The sector engagement can also be expanded if we avoid limiting labelling to products alone, in particular funds, as it would encourage greater integration of good ‘green practices’ into processes by analysts, discretionary managers and other financial service providers.
  3. The availability of specialised training would also support increasing standards and improve knowledge throughout the sector.
  4. In developing labelling, we would discourage approaches that required a form of quota in the fund of financial instruments or products which are specifically limited to ‘green’ investee companies. In contrast we would support identifying sustainability’-aligned business activities that either, benefit sustainability or, that would not do significant harm. This approach to labelling could be made transparent by being quantifiable but would not require a hard threshold.
  5. It would be helpful if any development in labelling also coordinate and develop in a manner that makes them comparable internationally so that we are not seeking to meet numerous, slightly differing standards. Maintaining the assessments necessary to keep the label(s) should be considered carefully, in order to avoid reporting for this purpose becoming so onerous that it results in diverting staff resources away from stewardship or act as a barrier to industry.
  6. Standardised reporting by companies on their activities would also ensure that information is more readily available to analysts to assess.
  7. We expect the need to increase reporting by asset managers on their stewardship activities will continue to grow in future, along with other reporting to ensure asset managers are not ‘greenwashing’. It is important that as regulatory standards develop to encourage visibility and accountability of stewardship activities, that the reporting burden does not detract resources from stewardship as well.
  8. Furthermore, whilst it is easy to suggest that only what can be ‘measured is done’, in stewardship, this could potentially have the perverse effect of short-termism and the incentive to only give messages to companies that are likely to result in an evidential change being made within a specific reporting timeframe. This is particularly acute if the assessment undertaken relies heavily on demonstrating results by the steward. Frustratingly, these important but difficult ‘requests’ for change as a result of stewardship, are generally more fundamental and impactful in nature and will require a long-term plan by a company. This is particularly in the area of decarbonisation where firms may need to move significantly along the continuum and potentially, change the business radically. We must therefore think carefully about the effectiveness of reporting to ensure it doesn’t dis-incentivise stewards from making these points.
  9. When developing reporting frameworks, we would urge greater work be done by regulators/standard setters and assessors, such as the FRC/FCA and in the assessment of by the PRI (Principles of Responsible Investment), to leverage the same ‘reporting’ information across their regulations/standards. Equally, it would be helpful that they ensure the timing of these reporting obligations are coordinated to serve more than one purpose. This will avoid the publication of confusing information that does not serve clients and would avoid investment managers being in a permanent ‘reporting mode’ which could act as a barrier to entry and discourage green product/service development.

What steps have UK banks, asset managers, and pension funds taken to ‘green’ their business models, investments strategies and balance sheets, taking in to account climate and transition risks? 

 

  1. Some firms have aligned their investment products issuing green bonds, themed investment, private equity aligned with green financing projects and with green debt to support infrastructure.
  2. For ourselves, as a discretionary private wealth manager, during the last 5 years we have undertaken a huge change in our investment process to incorporate ESG analysis into our investments. This has involved significant training and the development and expansion of an ESG dedicated team to spearhead progress and to provide expertise to the business. Whilst Ruffer undertook some stewardship activities prior to this, a more systematic approach has been adopted in the last 5 years to incorporate the ESG objectives into our dialogue with management of companies in whom we have invested. We have currently launched a project as a senior management priority, to establish how we might further develop our ESG offering and its integration into the business and our services.
  3. Our stewardship and ESG activities have been assessed by the UNPRI with A+, AA for a third year running which suggests significant standards have been successfully imbedded during that time. Nevertheless, to date we have chosen not to launch a ‘green product’ per se, as we have felt it more important to integrate ESG issues across our investment activities, rather than focusing attention in one area to the detriment of the rest.
  4. Finally, as corporates ourselves, many firms have begun foot printing their own businesses and establishing how to off-set the activities that are harmful.

Are there any barriers (regulatory or otherwise) preventing financial services firms from delivering green finance or investing in ‘green’ assets? 

 

Various challenges exists:

 

 

  1. Improved disclosure will be a key driver to progressing sustainable and responsible investment and a more sustainable economy in the longer term. Lack of standardisation and consistent comparable data from issuers (internationally), that asset owners can use to assess ESG risks and the impact this may have on our investor’s returns would be helpful. We welcome the ‘comply or explain’ approach adopted by the Financial Stability Board’s Task Force on Climate Related Financial Disclosures (TCFD). This is particularly helpful in ensuring corporates (internationally) disclose more consistently.

 

 

  1. Patchy knowledge or priority given to this across the investment chain has put a brake on progress e.g. brokers have been slow to integrate ESG in their buy and sell notes. These notes often suggest an anchoring to traditional assumptions that have limited their ability to convey scenarios brought about by climate change or other issues; In the case of investment advisors, they have sometimes lacked differentiated knowledge on ESG which limits the ability to ‘sell’ the investment process that incorporates more elements of ESG analysis and to understand/compare best practice.

 

 

  1. At present there is little consistency in the language used to describe responsible investment approaches. Greater understanding of the responsible investment approaches that exist will help investors to compare how investment managers’ actually invest responsibility on behalf of their clients and how they might be able to contribute to specific sustainability-focused preferences, as expressed by their clients. We support the work being undertaken by the IA to create a framework and glossary on the most common forms of sustainable investment. Labelling will also contribute to standards being more easily conveyed.

 

 

  1. For many clients, investment returns remain critical and they are certainly interested in sustainable investment but are unsure of the impact this will have on returns. In our experience, it has not yet impacted investors negatively, however, we cannot say this categorically as it may have more impact at different stages of the economic cycle and according to the timeframe against which this is assessed.

 

 

  1. The application and disclosure of the TCFD’s requirement for a multi-asset investment managers poses challenges with regard to carbon foot printing. Where multi-asset portfolio are unbenchmarked, they may not have a relevant comparator(s) and asset allocation may change multiple times a year.
  2. Furthermore, recent amendments by ESMA to a Q and A on the use of benchmarks has meant there would be significant implications to the incorporation of a benchmark in the EU in fund documentation. Additionally, the distinction of a benchmark as comparator does not exist in ESMA’s very recent approach. Industry is still trying to assess how the interaction of Benchmark Regulation with the various proposals under the EU’s Financial Sustainability Action Plan will work, in order to assess how workable it will be to use such indexes and for what purposes.

What prudential risks does climate change pose? 

 

  1. Climate change has been linked to increasingly severe weather events which in turn can lead to higher insurance claims and costs that are higher than anticipated for insurance firms. In the case of banks, it may mean that property for example, in flood risk areas are considered too risky to lend on; or, the cost of such business becomes prohibitive for capital adequacy reasons. Equally, forecasting extreme weather may impact lending in many other industries, some of which never ‘pay the price’ for the additional risk they eventually caused to the financial services provider they relied on, whilst others may disproportionately bear significant costs that are added to their service as a risk premium.
  2. The introduction of significant prudential requirements may ultimately have serious repercussions for individual consumers who may be faced eventually with products that are too costly to afford; or, in extreme cases, face the withdrawal of all providers for the service which - in the case of property - may leave the consumer with an asset that cannot be sold.
  3. In the case of industry, transition to a decarbonised economy may actually be thwarted by the withdrawal of lending or lending that becomes too costly for some industry to bear. However, given that weather patterns are inherently unpredictable, the real impact on assets will be difficult to map and accurately calculate a risk on in financial terms. Nevertheless, as described, the real impact on consumers for a potential risk based on broad modelling scenarios may lead to a heavy penalty for what may ultimately be an unrealised risk. This could have severe societal impacts that should be considered when adapting prudential risks as these costs may eventually be passed on. We must be careful in the process of calculating risks not to create stranded assets unnecessarily.
  4. Whilst we are well aware of the physical risks from climate change, the implications from transition risks are not as well defined. It may well be necessary to understand how best prudential risk can be expanded to include this. The incorporation of transition risks in the case of lending to industry, could have significant and varied results, potentially with premature impacts. To manage transition risk effectively, it would require matching expertise of those in climate change with those more experienced in transition risk to really understand how best to assess this effectively and fairly.

(a) What is the Financial Conduct Authority and the Prudential Regulation Authority doing to support decarbonisation and a ‘greening’ of the financial system?
(b) What expectations do (and should) they place on regulated firms about their role in the transition through their policy and supervisory activities?

 

  1. The work launched in March by the FCA and the PRA to host a Climate Financial Risk Forum (CFRF) is useful. It recognises the challenge facing the sector in enhancing their approaches to managing the risks and the obstacles faced in implementing changes that the risks might require. The development of a toolkit should hopefully help to avoid unforeseen consequences and give the financial industry an opportunity to develop thinking in this area. Recent consultations, such as DP18/8 (FCA) on climate change and green finance and CP 23/18 (BOE) suggest a willingness to engage on the challenges faced by the sector. It is clear that this has not been an area that is typically the domain of financial regulation and as such it is going to require the development of expertise. A great deal of financial services’ regulation is currently being developed in Europe. The speed with which this legislation has been adopted is unparalleled and there has been little time for industry to fully assess how the various pieces of legislation will work in practice and engage with legislators. We anticipate that there may therefore be unforeseen challenges for regulators and industry ahead in practical implementation. However, much will depend on how detailed subsequent elements of the regulation become.

What is the consumer demand for ‘green’ financial products?

 

  1. Whilst it is widely noted that millennials will be keen to consider ‘green financial products’, it is important to recognise that this is not yet the generation investing through asset management. Current investors generally remain focused as a priority on financial returns. We do however believe that these generations will be willing to embrace sustainable investing more broadly, but they are keen to know the impact this will have on returns. At present, asset managers lack sufficient data through varied economic cycles and along various timespans to provide a robust conclusion on the opportunity cost of investing in this way and this may be a challenge if we hope to channel investment into decarbonisation in particular in the short-term.

Does the current advice and KYC process effectively facilitate a consideration of sustainability preferences?

 

  1. In our experience the existing KYC and subsequent discussions with clients has often raised relevant issues which have led to restrictions being placed in addition to our integration of ESG risk in the investment approach.
  2. The European Securities Markets Authority (ESMA) has proposed changes on product governance rules (Q6 and Q7) to amend Article 9 and 10 of the MiFID II Delegated Directive. As such, this is an area of significant regulatory change at present and therefore it is really a little premature to conclude if the process is entirely effective.
  3. It should be noted that ESMA uses the terms ‘ESG’ and ‘sustainability’ as if they are interchangeable. In contrast, the EU proposals in a first instance seek to prioritise sustainable finance in the area of climate change mitigation and adaptation as evidenced by the working group (the TEG) tasked with developing a taxonomy of activities and climate-related disclosures in a first instance.
  4. Separately, we note that ESMA has assumed in its consultation that suitability of this nature would be captured through a questionnaire approach. We would note that whilst this might be the case on platforms or for some providers, we think this is not necessarily the best or only approach available to a discretionary investment manager. A one-to-one discussion with the client enables more to be shared on our actual approach to integrate ESG issues into our investment approach and then to assess if there are particular additional or specific client requests that need to be taken into account. Dependent on the client’s response, we then assess what the implications might be and how these could be achieved and whether this is possible to implement within the investment strategy and to manage on an ongoing basis. Following which, we discuss the conclusions reached with the client for their approval. This approach may need to evolve as we assess the regulatory requirements when finalised.

Ends.

 

 

31 July 2019

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