Sharadiya Dasgupta, Founding Partner, Blue Dot Capital
The Great Unraveling of 2020 demonstrated the futility of prognostications. Yet we present our 2021 ESG Outlook because even as the pandemic rages on and the world navigates the staggering challenges of mass vaccination, climate change and sustainable finance have indelibly captured the mainstream imagination. There is near-universal acknowledgement of private capital’s role in enabling the transition to a sustainable economic order. While the ‘how much’ and ‘how fast’ will be dictated by the economic recovery, multilateral diplomacy, political will, corporate participation, and other dynamics, there is scant doubt about the direction.
In this piece, we’ll explore our expectations for the upcoming year for ESG investing, focusing on the key areas of regulations, emerging markets, and evolution in ESG integration, among others. Tomorrow we’ll follow up with a deep dive into an emerging megatrend of sustainable investing – the Energy Transition.
Will regulations finally kick in in the US?
In November 2020, the Federal Reserve recognized climate change as a near-term financial stability risk. The Fed followed up in December by joining the Network for Greening the Financial System (NGFS), a voluntary group of central banks and supervisors formed in 2017 to promote and develop best practices for climate risk management. These steps along with the Fed’s engagement with Task Force on Climate-related Financial Risks (TFCR, part of the work of the Basel Committee on Banking Supervision), lead us to expect more principles-based guidance coming from the Fed in the near to midterm on monitoring and reporting of climate risks.
“We’re not the forum where all the great issues of the day are to be hashed out debated and addressed, unless and only to the extent that those issues are directly relevant to our statutory goals and are addressable through our legal authorities…..climate change is nonetheless relevant to our existing mandates under the law.”
Federal Reserve Chair Jerome Powell, December 2020
At the time of writing, Elad Roisman is the Acting Chairman of the SEC. In the past, Roisman has expressed “serious reservations about imposing prescriptive” ESG disclosure requirements. However, he is in favor of stronger disclosure requirements for those asset managers that have ESG, Green, or Sustainable funds as part of their product offerings.
All eyes will be on the new Chairman appointee to understand how the SEC will step up to respond to the very significant changes happening in the capital markets.
Sidebar: SEC’s Office of Compliance Inspections and Examinations (recently renamed to Division of Examinations) identified ESG disclosures as a stated priority in its 2020 exams. ESG will remain an examination focus area in 2021.
EU Sustainable Finance Action Plan continues to take shape
Many key elements of the EU Sustainable Finance Action Plan are planned to set in this year.
- Most notably, EU regulation on sustainability-related disclosures in the financial services sector, or SFDR, will go into effect on March 10. SFDR imposes new transparency and periodic reporting requirements both at a product and firm level for a broad range of investment firms like alternative investment and UCITS funds, discretionary account managers, pension providers and insurance-based investment product manufacturers.
- In Q1 2021, the European Commission’s Joint Research Centre (JRC) is expected to publish the final Ecolabel criteria for retail financial products. The objective of the Ecolabel is to provide retail investors greater information about the environmental impact of their investments. In a June 2020 testing of the draft EU ecolabel criteria on a sample of 101 “green” UCITS equity funds, only 3 funds qualified. JRC has since then presented an updated report with revised scope and criteria.
ESG Gaining Traction In EMs
2021 might be the year when ESG becomes a dominant investment trend in major emerging markets.
- EU and China are leading the development of the Common Ground Taxonomy under the auspices of the International Platform on Sustainable Finance (IPSF), an initiative backed by IMF and member countries including Argentina, Canada, Chile, China, India, Kenya and Morocco. The Taxonomy is expected to be developed by mid-2021 and will be a big step forward in enhancing transparency about what is “commonly green” in member jurisdictions and contributing to scale up cross-border green investments. Improving ESG disclosures and a vibrant local ESG data ecosystem, provide a strong impetus to consistent growth in ESG investments in China.
The Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) announced a sustainable finance strategy in December 2020. Highlights include: TCFD-aligned climate-related disclosures to be made mandatory no later than 2025, and plans to develop Hong Kong into a regional green finance centre. Policy recommendations and action items are expected to follow in 2021.
- In India, currently there are only a handful of ESG funds and total ESG AUM is well below $1 billion. Limited regulatory guidance, minimal, inconsistent ESG disclosures and a lack of investor awareness are the primary hurdles. However, large asset managers are actively exploring ways to develop robust in-house ESG approaches. India recently updated its stewardship codes which sets the stage well for collaborative engagement by the country’s largest shareholders to drive meaningful normative ESG changes.
- Thailand has consistently been perceived as a regional leader in ESG disclosures. Thailand’s Securities and Exchange Commission (SEC) even released a consultation in November 2020 about including a mandatory ESG training module as a requirement for investment professionals when renewing their licences. Government Pension Fund (GPF), Thailand’s largest institutional investor, launched the first domestic ESG fund in 2020. Regulatory clarity and asset owners’ demand will drive adoption in Thailand and we expect more ESG fund launches in the coming months.
- In May 2020, South Africa’s National Treasury published for public comment a draft technical paper: “Financing a Sustainable Economy” as a comprehensive framework for financial institutions to better disclose information on their green practices and investments. A Steering Committee and Working Groups have been established to support the implementation of the recommendations. Guidelines and directives on ESG disclosure standards, and governance approaches are expected in 2021.
- Finally, expectations of a sustained weak dollar coupled with high post-Covid growth have made investors buoyant about emerging markets in 2021 and beyond (the period of lukewarm EM returns might finally be coming to an end). We expect international capital inflows to accelerate the ESG adoption in key emerging markets.
Focus on Data Sustainability
Increasingly economic activities are driven by data, the repository of which is growing rapidly as ever more users’ digital interactions are captured by companies big and small. The premise of machine learning (ML) and artificial intelligence (AI) that more data allows improved information flow which benefits users, fails to mention the collateral ‘waste’ being produced since a lot more data is collected than usable by ML and AI models.
Add to that the enormous energy cost and emissions to maintain data and run algorithms, a problem is brewing. While data privacy is gathering momentum as seen in laws such as GDPR (General Data Protection Regulation) and CCPA (California Consumer Privacy Act), we expect the environmental footprint of Big Data to be an area of increasing concern to stakeholders. It is imperative to consider data a precious resource, and think sustainably about collection, use, and replenishment.
Continued Emphasis On Diversity As A Business Imperative
Diversity, equity, and inclusion (DEI) will be a hard metric that companies will be judged by. DEI will continue to evolve into a core business operational issue with leadership and board oversight versus being under the purview of only hiring and talent management. We will be awaiting the SEC’s response to Nasdaq’s stipulated minimum diversity on boards’ proposal.
DEI will also be a pertinent factor when evaluating asset managers and we expect other influential institutional investors to institute practices similar to Yale’s effort to track diversity.
Anecdotally speaking, we are observing multiple initiatives to develop racial and gender equity investment theses. The conversation thus far has been somewhat narrowly limited to venture capital. We foresee the racial and gender equity investment philosophy broadening to other asset classes and investment offerings.
Second Generation Of Asset Management’s ESG Integration
- Asset management firms will continue to bolster their ESG research and investment capabilities. The industry will start looking past the vanilla, ESG-integrated offerings so expect more active, thematic ESG fund launches.
- With the marketplace maturing, there will be greater scrutiny on the robustness of ESG integration, veracity and measurability of ‘sustainable/green’ claims, and track record. UNPRI, the world’s leading network of responsible investing is slated to roll out its new reporting requirements that will stipulate higher standards of ESG integration and signatory reporting requirements.
- We are seeing a lot of interest from managers of ‘less ESG-suited’ sub-asset classes like CLOs and specialty finance. It will be interesting to see how ESG integration evolves in a meaningful way in these pockets of the credit market.
- Asset management – driven by fee pressures, higher technology adoption, and need for scale – will continue to witness consolidation. We expect firms with a strong ESG product suite and track record to be on the M&A shopping wishlist. ESG played a part in last year’s biggest asset management M&A when Morgan Stanley acquired Eaton Vance (which had acquired ESG veteran Calvert a few years ago).
Enhanced ESG Data Capabilities
Reels have been written on the challenges of ESG data: Inconsistent disclosures, voluntary reporting, black-box projections’ calculations, and disparate methodologies. Our house view is that the inherent complexity of the ESG data patchwork renders the hopes of a perfectly aligned ESG scoring system misplaced and premature.
We expect the two 2020 ESG data trends to continue unabated in 2021: 1) Emergence of boutique alternative data providers that draw out ESG intelligence from unstructured data, and 2) continued consolidation of data providers.
We expect more attention on private market ESG data as well and won’t be surprised if more leading private market intelligence platforms launched their proprietary ESG data platforms.
Sidebar: France’s Autorité des marchés financiers (AMF) and its Dutch counterpart, the Autoriteit Financiële Markten (AFM), recently unveiled a position paper making a case for a European regulatory framework for ESG data. Although mandatory regulations for ESG service providers may seem ambitious in scope given the current market state, we will be closely tracking the proposal to see how it might guide future regulations.
Stay tuned for Part 2 of our 2021 ESG Outlook tomorrow, in which we dig further into one of the key sustainable investment areas, accounting for tens of billions of investment dollars over the next few years: the Energy Transition.
About the author:
Sharadiya is the Founding Partner of Blue Dot Capital, a consultancy that works with investors and investment managers to develop ESG and impact investing capabilities across asset classes. Blue Dot Capital’s clients and partners include single family offices, asset managers, alternative investment firms, private banks, and RIAs.
Before starting Blue Dot, Sharadiya was the founding Managing Director of Total Impact where she oversaw the development of new ESG advisory and educational resources. Prior to that, she was part of the transaction banking advisory team at Axis Bank (LSE: AXBC). Earlier in her career, she held product strategist and institutional client roles in investment management firms like BNP Paribas and Invesco, in India. In her 15 years in financial services, she has worked with a diverse array of capital allocators including corporate treasuries, endowments, foundations, family offices, and community finance organizations.
Education: MPA from Columbia University, MBA from Indian School of Business, B.Sc (Hons) in mathematics, SASB Fundamentals of Sustainable Accounting (FSA).