A primer on developing an ESG Investment Policy
Written in collaboration with the experts at InReg
The inclusion of Environmental, Social and Governance themes within investment practices and product offering has witnessed significant momentum in the recent past. The coordinated effort to channel resources to sustainable endeavours through finance, both at global and European level, has recently reached the point where sustainable finance products are about to become literally mainstream. This movement for the creation of a market for sustainable finance products sees some managers at the forefront and leading by example, whilst others, inevitably, scrambling to join the bandwagon of sustainability.
However, the shift to a long-term/sustainable type of investments doesn’t happen overnight and requires solid foundations, like a formal ESG investment policy. As we know it, the development of an ESG investment policy is far from being a tick the box exercise. Rather, it requires a coordinated effort and involvement of internal and external stakeholders, board of directors and C-suite. Once developed, continuous governance effort is required in order to implement the investment policy in the investment decisions as well as monitor its efficacy on an ongoing basis.
Whilst this article will be of particular interest to managers with essential resources, whose business model entails significant reliance on outsourcing of core functions, the principles highlighted herein will provide invaluable insight to all managers dealing with the sustainable finance revolution.
Align the right stakeholders and make them accountable
The recent movement to mainstream sustainable finance has shown how having an ESG investment policy is no longer a nice to have but a must have item. The process for the development of an ESG investment policy – or revision of an existing policy to integrate ESG considerations – is full of challenges. Managers are advised to pay particular attention to certain details if they want to be able to successfully develop an ESG investment policy that resonates with the overall vision of the firm and fits nicely with the operations alike.
First and foremost, it is crucial to line up and align the right stakeholders and team members from the outset. These stakeholders will need to take an active role and be accountable in the process of development or revision of an ESG investment policy. This first step is crucial but it doesn’t only mean that managers have to involve all the relevant stakeholders without significant omissions. It also entails that each stakeholder has to be involved at the right time in the process and be accountable for its part. It helps also to identify the type of input and responsibility allocated to each particular stakeholder/team.
It is also critical for managers to ensure that communication and feedback on the various issues is given and received in the course of the process accurately and on time. Whilst the existence of well-functioning communication channels is important for the success of these types of projects, this tends to be the most underestimated item on the shopping list.
Of course, there is no one solution fits all in terms of the right team and stakeholders to involve in the process of development of an ESG investment policy. Different firms have different internal structures and may rely to a different extent on both internal and external stakeholders. Suffice to say though that an ESG investment policy is not that different from other investment policies but poses nevertheless challenges especially for firms whose offering is new to sustainable finance.
No matter the internal structure, we find of paramount importance that the board of directors is involved from the very outset and throughout the course of the process of development of an ESG investment policy. In more practical terms, the development or revision of an ESG investment policy should be on the board meetings agenda for the entire time estimated for the process itself, be it two or three quarters or the even the entire year, depending on the setup, existing resources and success of the process.
Align the strategy with the policy and familiarise with legislations and trends
In order to be effective, an ESG investment policy has necessarily to resonate with the broader vision and mission of a firm. The challenge for managers engaged in developing ESG investment policies lies in making sure that this is the case. But how can this be done effectively and achieve the desired result of an ESG investment policy integrated with the overall vision and mission of a firm? One approach that seems to be successful is to look at the existing investment strategies first. As part of this approach, a thorough assessment of the investment strategy should be carried out before or at the same time when commencing the work related to the development or revision of the investment policies. The board of directors or the investment committee (or both) will have to consider whether and how current investment strategies take into account long-term trends as well as more broadly look at the take of the firm on ESG factors.
And right there we have another challenge. The incorporation of ESG factors into investment policies requires familiarisation at all levels, from the board of directors, to the investment committees and C-suite, with the relevant ESG regulatory and public policy framework. Whilst the pace of the current regulatory output in Europe on ESG themes is relentless, with some major pieces of regulation about to enter in force in 2021, none of the ESG related transparency, reporting and other regulatory requirements can be overlooked in the process of developing an ESG investment policy. Actually, these very regulatory requirements will become the foundation of any investment policy.
All stakeholders involved will have then to familiarise with the relevant legislation and be kept up to date with the trends on an ongoing basis. Again, depending on the size and structure of firms, different options are available, including the possibility to team up with external experts to provide the necessary support to board of directors and investment committees on relevant regulatory and public policy frameworks on ESG themes.
Internal or external? Good governance after all
Development or revision of an investment policy is most of all also a governance exercise. Governance on ESG themes shall be as rigorous as any other governance framework for investment policies. Accordingly, ESG investment policies should ingrain robust governance mechanisms to make sure that the principles contained in the policy are then applied correctly throughout the entire investment chain.
Depending on the size and structure of the firm, governance can also be classified in internal and external. An ESG investment policy shall identify clearly the governance duties of all stakeholders involved and those be divided into broad categories, like oversight, day-to-day execution and management. Governance should embrace all levels within the firm for their respective duties, from the board of directors and investment committees, for high level assessment of the policies, down to the C-suite, for approval and monitoring of execution, as well as investment and compliance teams, for further development and implementation of the investment policy.
Of course, when the model and structure of a firm calls for it, governance shall also embrace the work of any external partners or third-party stakeholders, with the creation of due diligence and ongoing oversight guidelines.
The time for sustainable finance is now
It is worth reiterating that the relentless pace of the regulatory output in Europe on ESG and overall sustainable finance themes is a clear indication that sustainable finance is now. Fund managers, especially the ones not traditionally part of the sustainable finance niche, have been preparing already and ramping up their operations and internal processes to be able to integrate ESG and sustainability in their offering and tap into the opportunities offered by the sustainable finance market being developed in Europe. Of course, the road to sustainable finance has its challenges, especially in the implementation of the new regulations at European level, however implementation can be smoother when supported by experts on ESG regulation.