Environmental, social and governance (ESG) concerns are no longer novelties. In fact, changing regulations and disclosure requirements are beginning to affect the operations of asset and wealth management (AWM) firms and the companies behind the assets they manage. This poses interesting opportunities and challenges for asset managers as intermediaries (though we should also note that AWM firms can create value through ESG in their own operations).
Some AWM firms have taken leadership roles in promoting best practices and delivering sustained outcomes, from ESG-oriented mutual funds to promoting transparency toward shareholders. But the work has often been done in pockets, and few companies have managed to make much progress across the board.
Here’s a look at seven challenges we’ve seen in AWM firms’ response to the ESG moment — along with some suggestions on how to reframe these problems into opportunities.
From the attention paid to 2016’s Paris Agreement to 2021’s United Nations Climate Change Conference in Glasgow, many people associate ESG with commitments to reduce greenhouse gas emissions. This is certainly an important component, but ESG has come to mean much more than that. AWM firms should understand the exposure of their investments, which is exponentially trickier to monitor and more potent in driving change.
Assess the risks and opportunities facing your investments across the full range of ESG issues. Identify actions that are material to the portfolio. There may be more than you think.
AWM firms have more opportunities than most to influence outcomes through ESG, but we don’t always see a coherent approach across these five “buckets” where they can make a difference.
In fact, AWM firms often address these inconsistently, in part because they are typically driven by different sets of stakeholders and decision-makers. And, even though ESG is an issue for boards, they may not be brought into the discussion when appropriate. Similarly, without a coordinated approach, firms could be perceived as inauthentic in their ESG approach. If you pursue an aggressive strategy and later need to walk it back, you could face resistance from investors.
Identify a central authority, either a person or group, and give them power to make real decisions. This will help you develop a central point of view, ensure alignment and drive efficiency in your ESG work. You’ll also want to keep your board updated about the potential for new risks and revenue opportunities.
What you measure, which data sources you use and how you report on results might vary considerably across AWM industry subsectors. Each subsector has its own structural issues and operational complexity, given varying transactional velocities and reporting expectations. You’ll likely want to have them ladder up to consistent standards across your firm.
Mutual funds present an array of revenue opportunities, with products targeting investments that highlight gender diversity, human rights and socially responsible corporate culture or investments that avoid issuers in industries that raise significant social or policy concerns.
Alternative investments may have the most diffuse set of ESG opportunities, with the least consistency in how ESG principles are measured. ESG issues are starting to affect asset valuation. In fact, 37% of respondents in our Global PE Responsible Investment Survey told us they’ve turned down investment opportunities because of ESG concerns.
Real assets investors may be particularly interested in environmental factors, with LEED-certified buildings attracting more attention from lessors and new concern for properties that might be vulnerable to climate change.
Design and apply your ESG strategy across different asset classes and funds. While the principles will remain consistent across your firm, each business line may need to address very distinct issues, with implications for people, processes and technology.
Many ESG revenue opportunities are directly tied to marketing efforts. There are often willing buyers, but they may not understand why your efforts deserve their attention.
ESG considerations may offer additional margin to offset pervasive fee compression. One study1, for example, showed that exchange-traded funds that explicitly focus on socially responsible investments have 43% higher fees than standard ETFs. But investment advisors and employees may need additional training if they’re to adequately address investor questions. This is particularly true when there are trade-offs involved, such as if you ask your investors to accept a lower rate of return on investments in exchange for societal or environmental benefits. (And, according to our recent global survey, 81% of investors would accept only a drop of 0-100 bps in exchange for societal or environmental benefit.)
Similarly, we know of firms that have chosen to participate in the industry’s Net Zero Asset Managers initiative, committing to work with asset owners on decarbonization goals on the road to net zero emissions — and then struggled because they lacked the data to support reporting requirements, didn’t fully understand the commitments they’d made or hadn’t effectively shared the plan with employees and distribution partners. Good intentions may fall short if you can’t show your work.
Sustainability-linked bonds (SLBs) present an interesting case study. SLBs, a subset of the rapidly growing global market for green bonds, target ESG-related projects like retrofitted buildings, renewable energy contracts and financing for minority-owned businesses. Issuers need to be able to identify and report on key performance indicators, some of which may be new to other market participants. While there are frameworks that can make issuances more credible, issuers — and, in many cases, AWM firms — may need to be prepared to defend their interpretations. This inevitably will affect AWM buying and marketing decisions.
Until ESG becomes a normal part of assessing investments alongside more traditional financial metrics, firms may struggle without a good understanding of individual buyer priorities, and targeting may not always be intuitive. One approach: Cross reference your list of investor targets with third-party data to get a more precise view of which aspects of ESG are most relevant to each buyer. Some data products, like PwC’s own Customer Link, can help you build an integrated view of individuals, households and key market segments to help you find receptive investors.
1 Wursthorn, Michael. “Tidal Wave of ESG Funds Brings Profit to Wall Street; Socially focused exchange-traded funds give asset managers higher fees in a low-fee industry,” Wall Street Journal, March 16, 2021, accessed on Factiva on November 13, 2021.
Revenue opportunities are often directly tied to how you spot customer opportunities and explain your efforts. Be prepared to offer data-driven communications to clients and client-facing teams that demonstrate how you’re addressing each buyer’s needs.
While there are no unified global standards for reporting ESG information, there may be more clarity than it seems. Companies touting their ESG capabilities could soon be required to show that their ESG activities meet expanded regulatory standards.
In the US, for example, the SEC published a risk alert in 2021 that raised concerns about investment practices that were inconsistent with disclosures; inadequate controls and ongoing monitoring around ESG-related investments and marketing materials, and more. This follows a 2020 request for public comment on the status of the “Names Rule” requiring a fund to invest at least 80% of its assets in investments implied by the fund’s name. As the number of funds identified as “sustainable” has soared in recent years, so has scrutiny of the ways they’re marketed.
We also anticipate additional ESG regulations and rules from the Department of Labor (DoL) involving pension/benefit plans and transparency involving third parties. The DoL recently asked for comments on a rule change that could make ESG a more prominent part of plan investments2. We’ve seen similar ESG requirements introduced by California and New York and by public pension funds in Canada and the United Kingdom. This is an evolving topic, and firms with large footprints could be exposed to a variety of different rules.
Finally, taxes (both income and non-income) are a critical and often overlooked part of a company’s overall ESG strategy. As companies begin to consider ESG implications more closely, they may identify new opportunities (or uncover existing risks) relating to tax strategy and operational footprint. Over the past year, we’ve seen a wide range of proposals at the state and federal level tied to minimizing the costs of physical climate risk and maximizing the benefits associated with the climate transition, such as the reinstatement of the Superfund excise tax (for the production of certain hazardous chemicals) and myriad credits and incentives for the development of renewable energy infrastructure and associated industries such as utilities, technology and construction.
2 Welsch, Andrew. “Labor Department to Reverse Trump-Era Rules That Curb ESG in Retirement Plans,” Barron’s, October 13, 2021, accessed on Factiva on November 13, 2021.
Companies that align their tax and ESG strategies may be able to achieve their ESG goals while reducing or mitigating their after-tax cost and non-income tax burden (or increasing the benefits) from achieving those goals. As regulations and tax codes evolve to keep pace with fast-moving ESG norms, you’ll want to make sure your policies, disclosures and tax strategy are up to date and appropriately positioned.
Accelerating demand for greater reporting requirements from investors and regulators has led to an additional challenge for companies: collecting, managing and disseminating the data used in their ESG reporting.
ESG data is different from traditional financial metrics, so it may be harder than you think to collect, manage and disseminate the data you’ll use in your ESG reporting. For AWM firms that are aggregating information from investment holdings, it may be difficult to even determine what you don’t know. While financial statement reporting is increasingly automated, with appropriately designed controls and processes, ESG metrics do not have universally accepted definitions. Data may be missing, and accuracy can be inconsistent.
To address these gaps, there’s a growing number of software options designed to generate enterprise level analytics around how you gather information. Some vendors have begun to provide ESG-related data and analytics as part of their service offerings. Tools like PwC’s ESG Pulse can help uncover issues related to data availability, accuracy, controls and governance to help you swiftly move to fill in gaps, enhance your reporting capabilities, drive transparency and build trust.
While many of these approaches are new, you’ll want to think about how you can use them to craft a systemic approach now, in anticipation of a growing demand for more real-time data.
ESG data may be harder to source and more challenging to validate compared with traditional business data. Software options can help you meet the demand for enhanced ESG reporting requirements.
We’ve found that if companies take the right actions on ESG, investors will support them, but they want to be brought along for the journey, recognizing that it may take years to complete. That means being upfront about the prospects for long-term value creation and the ways in which firms will manage risks, including unexpected ones.
As an asset manager, you should be prepared to show the work for the companies behind the assets you manage. How these companies address litigation, supply chain disruption, data stewardship and cybersecurity, physical health, compliance and similar risks has now become a particular topic of interest for investors. To that end, there are a growing number of frameworks and independent organizations that attempt to quantify these risks, among them the newly created International Sustainability Standards Board (ISSB), the Sustainability Accounting Standards Board (SASB), the Task Force on Climate-Related Financial Disclosures (TCFD), the Climate Disclosure Standards Board (CDSB) and the Global Reporting Initiative (GRI). But third-party data isn’t always transparent, and investors will want to know how much they can trust ESG claims. To help with this process, PwC has begun to provide attestation around quantitative issues like employee diversity and inclusion, greenhouse gas emissions, employee health and safety, and data security — and qualitative items such as application of an ESG policy to funds.
Your investors will want to know that they can rely on ESG claims. Independent reviews will help here, and there’s a growing number of standards organizations dedicated to ESG risk assessment. PwC also offers attestation services to help companies and investors understand their exposure.
As we see it, societal needs and business opportunities are coming together to transform the way companies craft strategy, drive performance and report results. As your firm approaches the ESG revolution, it may be useful to ask yourself what you must do, what you could do and what you should do.
At AWM firms, ESG clearly has many components that touch so many different elements of the business. In fact, we see that while executives often focus on ESG issues, there’s little alignment on goals or even who’s driving. With sometimes conflicting messages from the C-suite, individual business units, a dedicated ESG team and even product managers, this is beginning to look like a matter of herding cats.
The stakes are high — for society (metaphorically) and for the immense revenue opportunities (literally) that ESG may represent. But unlike some other big market forces, there are many ways to make incremental progress that offer value today and flexibility for tomorrow. And that’s good, because AWM firms will likely feel more pressure to address ESG issues and opportunities in coming years, spurred by investors and shareholders, governments and policymakers, employees, suppliers, customers and others. Whether your journey starts as a response to a new reporting requirement or reflects a top-down strategy refresh, these seven challenges and opportunities may help you identify and realize significant new sources of value creation.