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March 2021 | Issue 232
Opinion ESG
A transformational framework means fund managers have to drive real-world change
Fatima Hadj
Chairwoman, structured finance advisory board Principles for Responsible Investment
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There are managers who make transformational investments, those who incorporate ESG and those who do nothing
As private debt investors, our fiduciary role is about looking after capital, deploying it appropriately and ensuring returns do not undermine the sustainability and liveability of our planet. Because of their capital allocations, private debt investors have an important role to play in helping society address risks such as water shortages, the climate crisis, inequality, population growth, geopolitical uncertainty and technological disruption.
To move towards a ‘transformational investment’ mindset requires a solid foundation and for fund managers to move from an outside-in approach, which centres on how sustainability issues affect financial risk management, to an inside-out approach using investor influence for a positive, transformational change. A recent DWS report, A transformational framework for Water Risk, examined what this means in the area of water risk.
For the debt market, a transformational/impact framework means aligning the incentives for fund managers to elevate their stewardship role and drive real-world change, rather than focus on financial ESG risk management. It is the concept of double materiality: financial, which references what is affecting the value of the company; and environmental and social, which references the impact on climate change and society.
Investors face a Babylon tower of ideas and approaches, characterised by ambiguity about the definition of risk and incorrect alignment of roles along the investment value chain.
Governments, European Union accountants and investors have responsibilities to shape sustainable finance. A transformational framework must ensure that the financial industry and individuals as consumers, citizens or retail investors are clear about what sustainability means. To do so requires the concept of separation of powers to be made relevant for the investment chain.
Governments should legislate with stronger policies on water, climate, inequality, biodiversity, etc. The European Council and the European Parliament should lead by harmonising European ESG regulation. And accountants should measure full ESG in Globally Accepted Accounting Principles (gaap) when auditing countries, companies and investors. Maybe this will start to happen through the International Financial Reporting Standards.
However, the onus is still on investors to implement an investment framework across all asset classes with a clear distinction between ‘do nothing’, ESG integration (outside-in) and impact/transformational investment (inside-out).
We suggest governments should aim to set a positive impact principle within sustainable finance regulation. It’s the opposite of the old polluter pays principle, underpinning the first credit carbon fund I worked on in 2005. The mindset matters. We have moved from “I can buy the right to pollute” to “I demonstrate that I have a positive impact” on the planet and society at all levels.
Principles and regulations are required
Words matter — and principles too. We need to build a positive mindset policy and regulator framework to incentivise stakeholders to position themselves as positive contributors. This is where governments can intervene, applying a sustainability tax to investment products, and rewarding those addressing sustainability goals.
Alignment of interests is the cornerstone of logic in the investment world. Therefore we could see lower/no government sustainability taxes for impact investments, intermediate rates for ESG integration investment products and the highest rates for investment products that do nothing.
Failing to achieve a transformational framework will likely condemn water and other ESG factors to remain as risks that investors simply try to avoid, even though multiple environmental and social changes will become huge challenges during this decade.
Co-authored by Murray Birt, senior ESG strategist, DWS

In our next column, we will present the innovations in financial products that capture ESG impact and the challenge of keeping an alignment of interests between all stakeholders. There are some mechanisms correlating the cost of capital to pre-defined ESG KPI through ESG-linked loans and bonds. The alignment may seem obvious, but it is not.
Principles for Responsible Investments is a UN-linked campaigning organisation committed to keeping market participants posted on the key milestones, industry actions and ESG tools that can help transition portfolios to net zero carbon.
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Global credit funds & CLO's
March 2021
| Issue 232
Published in London & New York.
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