September 2021 | Issue 238
Opinion CLOs

Do not rush to set up a check-box approach with negative screening and start de-investing

Fatima Hadj
Chairwoman, structured finance advisory board Principles for Responsible Investment
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Instead of rushing through an ESG framework, asset managers need to adopt a long- and short-term approach
It’s been a busy summer. But if there is one thing you need to catch up on it’s the ‘green deal’, after the EU Commission published its ‘Fit for 55’ package in mid-July.
This is the legislative framework that aims to cut carbon emissions by 55% by 2030 (relative to 1990). With its green deal, the EU declared its ambition to make Europe the first climate-neutral continent in the world and, with its Fit for 55 package, provided a roadmap of its plans.
In my previous column, I drew attention to the acceleration of the policy response to tackle climate change and the unprecedented project to review more than 50 European laws. Those initiatives are nearing completion and so the pace will accelerate.
Having said that, Fit for 55 still requires approval by member states and the European parliament, a process that could take one or two years. But that is still a short time-frame, because the implications for the financial industry are as transformational as they are for all sectors of the economy. Indeed, the first 10 legislative changes from Fit for 55 will impact all asset classes.
The challenge for asset managers is to determine how to use this legislative step as a roadmap to build an ESG strategy for their investments.
Think, don’t just react
My advice is to not rush into setting up a check-box approach with negative screening and then start de-investing. Constantly adapting to the pace of regulations, which are developing fast, could be costly to your organisation and investors. You don’t lead by reacting.
ESG is a world under construction, with multi-dimensional aspects in a geopolitical situation characterised by its high degree of uncertainty. The coronavirus pandemic has reminded us how uncertain the future is — both in the long and short term.
The European Investment Bank, one of the world’s main funders of climate investments, highlighted in its last report that uncertainty over regulation and taxation hampers climate investments. You can see the irony of the situation — we have to be prepared for the unexpected.
My methodology for capturing uncertainty combines long-term and short-term approaches.
The long-term approach is most of the time underestimated by investment committees. It is more than the macroeconomic view — global challenges will produce widespread strains on states and societies that will impact all investment opportunities. In a world that has become more interconnected, it is risky to build a portfolio by only focusing on the sectors you are investing in.
Enter the execution roadmap
For the short-term approach, the implications are integrated into investment decisions. With the ESG regulation, a new parameter emerged: the execution roadmap. What do I mean by execution roadmap? It’s the ESG engagement plan.
Actively engaging with your investors to help them transition their activities is not purely a concern for equity investors. Even debt holders have to engage with investors and it can’t be left to the sustainability office.
Just as for the long-term approach, ESG engagement is not usually integrated into the investment process. One of the reasons is the difficulty of assessing climate transition risks. Indeed, contrary to the physical climate risks, which are easier to observe, the climate transition risks are more complex and harder to identify due to uncertainty about the long-term horizon of their impacts.
Actually, in the financial market, complexity creates opportunity. One way to have a positive impact on society might be to buy low-ESG companies and engage with them to transition their businesses. This would lead to a financial re-rating of those companies and strengthen the resilience of the portfolio.
Asset managers must not only adapt their investment process, they must also transform themselves. This transformation will also impact the product creation and distribution value chain.
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Global credit funds & CLO's
September 2021 | Issue 238
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