Seismic Change for the Asset Management Industry
The expectations around COP26 are high. Since the last ‘significant’ COP, we have experienced unparalleled change; a global pandemic, rapid acceleration of technology, accentuated social inequalities and acknowledgement that climate change is not going away. Whilst we need to manage expectations around any COP being a true panacea, there are number of themes which are starting to emerge and will likely dominate the foreseeable landscape. Many of these themes will have seismic implications for financial services, including the asset management industry.
Transformative themes include:
1.Sustainability-related regulation (more than just what’s written in law) – The past year has seen a foundational shift in asset managers’ sustainability and responsible investment strategies, particularly for players operating in European markets. Rates of regulatory change vary geographically, but regulators across the globe are almost exclusively enhancing their expectations. Asset owners’ adoption of voluntary codes is driving change in investment decision making as well as tactical and strategic asset allocation processes. In addition, asset managers are seeking to embed a sustainability vision that offers a compelling solution for their clients. Either way, mandatory and ‘voluntary’ commitments will drive the scope of regulatory scrutiny.
Asset managers require a credible and well documented approach to implementing these commitments to avoid significant regulatory scrutiny.
2. It’s no longer just about climate– An almost certain outcome post-COP26 will be the industry-wide adoption of Net Zero to demonstrate commitment to battling climate change. However, new and interconnected themes are emerging such as natural capital, biodiversity and water risk. COP26 will shine a spotlight on these themes, and in the months to follow investors will be asking asset managers how they consider these ‘difficult to visualise’ yet increasingly critical issues. COP26 will also highlight supply chain shocks and ownership debates for sustainability-related outcomes – linked to carbon accounting and the opportunity for natural capital and other biodiversity metrics to ‘leap-frog’ into emerging accountancy standards.
Asset managers need to prepare for the significant obligations that will arise from becoming a Net Zero signatory and ensure they have credible, progressive approaches to emerging sustainability themes.
3. Sustainability oversight effectiveness will drive an increase in transparency – One industry’s material risk is often another industry’s biggest growth opportunity. However, all opportunities come with risks, including that of false promises. Accordingly, scrutiny over sustainability risk oversight processes will increase from investors and regulators. Asset managers will need to significantly accelerate the integration of sustainability-related risks into broader risk management processes and consider how technology can avoid inefficient ‘bolt on’ approaches.
New tools and the use of data and technology will be critical to driving effective oversight, management and reporting on these risks.
4. Double materiality becomes ‘Business As Usual’– Double materiality is an emerging topic which identifies the impact of external factors on a business as well as the business’s impact on the external environment. Asset managers will be expected to demonstrate careful consideration of the material impact ESG externalities could have on the going concern of their business. However, these entities will also need to demonstrate the external impact of their products and business model in the markets (i.e. both supply and demand) in which they operate. Laws such as Article 29 in France are starting to set the scene for double materiality reporting, requiring companies to provide greater analysis and disclosure of biodiversity impacts and other ESG risks beyond climate. This information will inform discussions around appropriate levels of cost of capital, discount rates and what transitional strategies investors choose to finance.
A robust data architecture and governance framework will be essential as asset managers look to report on double materiality.
5. Differentiation of leaders and laggards – As asset managers begin to catch up with each other in regards to ESG integration across their investment products and processes, we will see a reconfiguration of the leaders and laggards driving responsible investment and capturing sustainably-focused AUM. Challenges around data integrity, operational scalability, authenticity in ESG, and demonstrable outcome reporting for clients and regulatory compliance will be the key levers that asset managers will need to focus on enhancing.
Those players that can build flexible, scalable, and adaptable operating models, who invest significantly in raising knowledge levels of ESG issues at every level within their organisation, and who use a balance of technology and partnership with third parties will ultimately comprise the peloton of future ESG asset management leaders.
- Asset managers and owners will likely be judged in future not just on their ability to withstand volatile market conditions, but also for the wider positive or negative impact their investments have on the world.
- The future asset management leaders will have flexible and scalable operating models, act with agility in identifying and managing emerging risks, and be able to provide relevant, credible and outcome-oriented reporting to clients, regulators and other industry stakeholders.
How Can Alpha Help?
We’re witnessing the most significant industry transformation in a generation, and it’s no longer feasible to expect existing teams to complete this work ‘side-of-desk’. Please reach out to Troy Mortimer or to our ESG & Responsible Investment Practice if you would like to learn more about how we can support you in responding to these changing market forces.