Insight & Analysis

Pioneering ESG asset managers well placed to weather new EU disclosure rules

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Established sustainable investment fund managers could benefit from first mover advantage as tougher EU rules for the growing sector head towards ratification.

Asset managers that are already pioneering sustainable investment will benefit from new, stricter EU rules on disclosure and transparency requirements for the sector, according to Moody’s.

The ratings agency argues that asset managers that have already built similar provisions into their processes and adopted environmental, social and governance (ESG) disclosures prior to the release of the new rules may benefit from a first mover advantage position.

The European Parliament and EU member states reached political agreement on the new rules on 7th March. EU ambassadors must now endorse that agreement, and after that the European Parliament and Council will be called on to adopt the proposed regulation at the first reading.

Vanessa Robert, Senior Credit Officer at Moody’s, says asset managers that have been pioneering sustainable investment “will likely attract new inflows because demand for sustainable investment strategies is growing fast and investor confidence in the transparency of the ESG market will be boosted by these new rules.”

Robert says, however, that the new rules will also raise operational and compliance costs, which will weigh mostly on the profits of small EU-based asset managers that are ESG laggards.

She explains that the rules aim to eliminate “greenwashing,” the practice of making misleading claims about investment products' sustainability characteristics. They also aim to provide investors more clarity on ESG investments.

The rules will require asset managers in the EU to report ESG risks and opportunities as part of their fiduciary duty. Most notably:

  • Asset managers must disclose the procedures they have in place to integrate ESG risks into their investment-making process.

  • Asset managers must disclose the extent to which those risks might affect their investments' profitability.

  • Asset managers pursuing a green investment strategy must disclose how this strategy is implemented and the sustainability or climate effect of their products.

The rules include a transparency framework so that end-investors can better understand how asset managers take sustainability factors into account. The European Commission is working with co-legislators (the European Parliament and Council) to establish a unified EU classification system, or taxonomy, of sustainable economic activities, which should make ESG investing and reporting easier.

Moody’s argues that for asset managers that have the appropriate infrastructure, expertise and product range, the rules will likely lead to increased inflows into sustainable strategies, given increasing demand for ESG products – it estimates ESG funds in Europe have grown 16% a year since 2010.

Research by financial data provider Morningstar, meanwhile, shows that in Europe the asset class proved resilient during 2018 despite a difficult market environment that was marked by elevated volatility and broad declines in stock and bond prices.

Morningstar’s research found that while net flows into European-domiciled funds that incorporate ESG factors fell to €34.4bn in 2018 from €57.9bn the previous year, the 40% decline in new money was significantly smaller than the 80% slump suffered by the overall fund universe. Assets in sustainable funds were down by 1.3% to €684bn at the end of 2018 but that also compares favourably to a larger decline in overall European fund assets of 3.9% over the same period.

Moody’s says the EU’s new rules for ESG will require asset managers to update their product offering and prospectuses and explain how they include ESG factors. That will attract “heavy one-off implementation costs”, it says, estimating that asset managers’ costs could increase by 0.25%-2% depending on their current ESG capabilities.

Robert believes the costs will be relatively steeper for smaller players without ESG expertise. Asset managers with growing ESG involvement and an innovative product suite, such as LGIM, the asset management arm of Legal & General Group, Aviva, Standard Life Aberdeen and Amundi are best positioned to absorb them.

The more stringent disclosure rules will also require new systems or enhancements to current systems, potential new headcount, as well as the need to train salespeople to adequately explain the considerations. Robert says that operating costs (excluding compensation) for independent European asset managers have been rising, reaching 13% of gross revenue in June 2018 from 10% in 2016: “The new requirements will further increase asset managers' operating and compliance costs and likely negatively pressure margins.”

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