Prudential - Sir Isaac Newton’s first law of motion and ESG
6 August 2021
Catriona McInally
Business Development Manager - Investments
Newton's first law says that an object in motion will remain in motion in the same direction unless acted upon by an outside force; an object at rest will remain at rest unless acted upon by an outside force.
Why have I quoted this? Well for some bizarre reason I felt compelled to think about ESG in this context…..because I believe the power of ESG considerations in investing is very much driven by investors feeling compelled to change the state of the planet, and not only is it already in motion, its momentum is increasing exponentially.
Back to earth….It seems to me that you can’t read the trade press without hearing about another fund launch with ESG friendly features. That’s not unreasonable when you consider the level of customer interest in the whole subject, - with the pandemic seemingly accentuating this even further. However, what is less commonplace is some practical assistance on what advisers could and should do about embedding this in their suitability processes.
The new disclosure requirements for advisers with respect to their environmental, social and corporate governance (ESG) policies applies in the European Union from 10 March 2021 under the Sustainable Finance Disclosure Regime. These have not yet been embedded for UK advisers, though the UK government has committed to being at the forefront of suitability and will implement its own ESG disclosure regime, so it is likely that we will mirror most if not all of these requirements in the near future.
These rules are very comprehensive, but in short the following is likely to apply
- Obtaining and defining the preferences of clients in respect of ESG, as part of the suitability process
- Mapping these to funds
- Providing ongoing maintenance to ensure the fund choice remains suitable
But should advisers start asking advisers questions now about ESG to ascertain their clients thoughts? Well, yes, but caution is needed. For example ESG is an all-encompassing term and could relate to any of the following
- Ethical
- Sustainable
- Impact
- Socially Responsible
- Climate
- Etc!
To put it another way, you might end up with the ESG tail wagging the investment objectives dog. Take the potential situation where the client is a low risk investor but ends up with a high risk portfolio to satisfy a sustainability preference. The adviser runs the risk of not meeting the clients overall objective, and potentially opening themselves up to a complaint.
In practice the adviser needs to consider two points
- What overhaul of their know your customer process is needed, to drill down to a suitable level to really determine a clients ESG requirements & preferences
- What change is required to their overarching suitability process/centralised investment proposition/centralised retirement proposition to effectively deal with the client’s wishes.
Also, the potential consequences of not doing so need to be considered. Whether advised or non-advised, the marketing activity of financial distributors is already in full swing, and likely to ramp up even further over the next few years, in line with awareness levels generally. Advisers could be leaving themselves open to challenges from existing customers if they don’t start to discuss these issues with existing clients. No one wants the phone call from a client that say “why didn’t you tell me that my pension was invested in XYZ, when there was an alternative fund I could have used to help the planet as well”!!
So, in summary I think advisers not embedding ESG in their businesses will be like trying to defy gravity. And let’s be fair, Sir Isaac knew how difficult that was!
