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Implications of ESG regulations on asset managers and their financial lines insurances

In this article, we outline the main new ESG focused regulatory requirements faced by asset managers and how best to navigate them.

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Environmental, social, and governance (ESG) has risen in awareness and popularity over recent years, especially with asset managers. Estimates suggest that ESG assets may reach $53 trillion by 2025, nearly one third of global assets under management (AUM).[1] However, as ESG investments have increased in popularity, so has the attention of regulators. Probes into ESG investments have found that some funds are potentially misleading investors into how much their investments align to ESG principles. This has been deemed a form of “greenwashing”.[2] Due to greenwashing allegations, regulators are developing regulation to protect consumers and to prevent ESG being undermined. The last two years have seen a raft of regulations aimed at ESG; asset managers need to navigate the different regulations and assess their implications. Asset managers also need to ensure that they are fully supported by their financial lines insurances. This article outlines the main new ESG focused regulatory requirements faced in the UK, Europe, and the US by asset managers and how best to navigate them.

SFDR

The European Commission’s Sustainable Finance Disclosures Regulation (SFDR) for asset managers came into effect on 10 March 2021. SFDR requires asset managers to disclose how ESG plays into their business on an entity level (Level 1) in a prescriptive and standardised format.[3] 2022 will see the introduction of Level 2 disclosures, which will see asset managers making ESG disclosures on a product level. SFDR sits alongside exiting sectoral regulation, such as the Alternative Investment Fund Managers Directive (AIFMD), Undertakings for the Collective Investment in Transferable Securities (UCITS), Solvency II, Insurance Distribution Directive (IDD), and Markets in Financial Instruments Directive (MiFID) II, to promote harmonisation and cross-sector efficiency.[4] It is important to highlight that SFDR denotes differing disclosure requirements on a product level — for products with express ESG credentials as well as for products with no advertised ESG credentials.[5] A recent study of European asset managers has highlighted that lack of credible and available data has presented a significant hurdle to meeting SFDR requirements, with many citing that meeting SFDR has also brought considerable cost to their firm. Countering this, 65% of respondents said that SFDR had meant that their business plan had been adapted to direct more resources towards ESG risk measures and reporting.[6] This demonstrates that SFDR has helped to focus asset managers’ attention on ESG risks and has accelerated action in this space.

TCFD

The Task Force for Climate Related Disclosures (TCFD) is an industry-led group that has developed a climate reporting framework. TCFD has been adopted in the UK and Switzerland and hinges on four pillars:

  • Governance: Disclose the organisation’s governance around climate-related risks and opportunities.
  • Strategy: Disclose the actual and potential impacts of climate-related risks and opportunities on the organisation’s businesses, strategy, and financial planning where such information is material.
  • Risk management: Disclose how the organisation identifies, assesses, and manages climate-related risks.
  • Metrics and targets: Disclose the metrics and targets used to assess and manage relevant climate-related risks and opportunities where such information is material.[7]

The first round of TCFD reporting in the UK started for accounting periods beginning 2021 with the first annual reports, including TCFD reporting, released from Spring 2022.[8] The UK has opted for a staggered start to TCFD with many asset managers falling into the first and second wave of reporting. To be included in the first wave, companies will need to have more than 500 employees. Although a good step towards encouraging decarbonisation, critics have sighted that TCFD doesn’t focus enough on the ‘S’ and ‘G’ of ESG, both of which are set to become more scrutinised in the coming years. Similar to issues that EU firms are facing around data, UK firms have also expressed that obtaining data to conform to the TCFD framework is challenging and may require support.[9]

SEC

Although not yet in effect, the US Securities and Exchange Commission (SEC) have proposed new rules that will require asset managers among other firms to publish extensive climate disclosures. The SEC’s framework has a strong focus on publishing greenhouse gas emissions as well as the climate risks faced by businesses. Critics have been quick to hit back at the SEC’s proposals citing that it would end up proving costly to investors.[10] The SEC has rebutted, claiming that the aim is to better inform investors and allow them to make better decisions. The SEC first recommended that companies, including asset managers, consider reporting on climate metrics in 2010, but due to the lack of data the uptake has not been significant on a voluntary basis.[11] The SEC have been active in investigating greenwashing in recent months; three high-profile financial institutions have been investigated and in some cases fined this year for greenwashing allegations. Therefore, although not yet in effect, asset managers subject to the incoming SEC regulation should begin their preparations now.

Impact on asset managers

We have explored ESG-related regulation on disclosure reporting from three key territories for asset managers. Although there are consistent themes in the frameworks for ESG disclosures, there are two key issues that asset managers are facing. First, the lack of an international standard for reporting makes it difficult, costly, and time-consuming for global asset managers to ensure they are fulfilling all of their disclosure requirements in their relevant jurisdictions. Second, the lack of quality data surrounding ESG metrics is hindering the reporting process and undermining the credibility of the disclosures that asset managers make. Work is being carried out to standardise reporting practices, with groups such as Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) attempting to bring standards into line.[12]

In a recent study from PwC, ESG Transformation, 63% of respondents said that a lack of international consistency in ESG regulation is creating either a ‘very significant’ or a ‘significant’ challenge. However, 44% of firms said they see a very significant opportunity to develop new product ranges in response to changing consumer preferences on ESG[13] The good news is that creating an international ESG disclosure requirement seems to be more of a ‘when?’ than a ‘will they?’, as more countries develop regulatory frameworks. This demonstrates that more countries are engaging with ESG, which should provide momentum to develop an internationally recognised framework. An international forum also allows for influence from asset managers to push for regulation that meets the aims of governing bodies and ensures that regulation still allows for innovation.

The lack of good quality data for ESG disclosures has accelerated a push to source data — this may not have happened if regulation had not come into effect. Over the coming years, it is reasonable to expect that asset managers will be investing heavily into sourcing ESG data and to allow for better reporting, governance, and planning which should have positive externalities on funds and allow them to differentiate better and ensure profits in the transition to decarbonisation.

Implications on financial lines insurances

The landscape on ESG reporting is changing quickly and as such asset managers need to ensure that their financial lines insurances are equipped to support them in the event of a claim relating to ESG disclosures. First, asset managers should seek to increase their entity investigation limits if sub-limited or removed from their policy; as we have seen with the recent high profile probes into asset managers, investigations are likely to become more frequent. Asset managers should also check that they have adequate cover for civil fines and penalties if insurable at law should they receive a fine from a governing body. Policyholders should also ensure that they resist any potential restrictions to policy language on defence costs. Finally, if available, asset managers should seek a reinstatement for ESG specific investigations. To learn more, please speak to your financial lines representative.

To help understand ESG risks, Marsh has recently launched a free ESG Risk Rating tool. We recommend the tool to asset managers to allow them to take a deeper dive into their ESG strategies. To learn more about the ESG Risk Rating tool, and any of the topics raised in this article, please contact your local Marsh representative.

 

[1] https://www.bloomberg.com/professional/blog/esg-assets-may-hit-53-trillion-by-2025-a-third-of-global-aum/

[2] https://www.burges-salmon.com/news-and-insight/legal-updates/commercial/how-green-are-you-greenwashing-claims-scrutinised-by-regulators

[3] https://assets.kpmg/content/dam/kpmg/ie/pdf/2021/03/ie-sustainable-finance-disclosure-reg-sfdr.pdf

[4] https://ec.europa.eu/info/business-economy-euro/banking-and-finance/sustainable-finance/sustainability-related-disclosure-financial-services-sector_en

[5] https://www.simmons-simmons.com/en/publications/ck6tebyfu23b30937xukyszhi/the-eu-disclosures-regulation-key-requirements-for-asset-managers

[6] https://citywireselector.com/news/sfdr-compliance-adds-costs-and-time-research-shows/a2384286

[7] https://www.fsb-tcfd.org/

[8] https://www.osborneclarke.com/insights/are-you-ready-mandatory-tcfd-reporting-uk

[9] https://www.omfif.org/2022/04/data-data-data-remain-biggest-challenge-to-tcfd-adoption/

[10] https://news.bloomberglaw.com/esg/nasdaq-urges-sec-not-to-move-ahead-with-climate-disclosure-plan

[11] https://www.resources.org/special-series-sec/international-context-of-the-proposed-climate-disclosure-rule-from-the-us-securities-and-exchange-commission/

[12] https://www.global-counsel.com/insights/report/global-esg-reporting-standard-where-are-we-and-where-are-we-heading

[13] https://www.pwc.co.uk/financial-services/assets/pdf/esg-transformation-july-2021.pdf

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