Regulation will be a driver of demand for specific ESG capabilities

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The challenge UK asset managers face in balancing their fiduciary duty to deliver returns to clients with the growing demand from investors and regulators for investments to be sustainable has intensified recently, according to the latest The Cerulli Edge—Global Edition.

Cerulli Associates, a global research and consulting firm, believes that UK asset managers should brace for increased scrutiny of their environmental, social, and governance (ESG) capabilities. They must respond to the updating of the country’s Stewardship Code by the Financial Reporting Council, the introduction of additional policies relating to pension funds’ statements of investment principles (SIPs) by the Department for Work and Pensions, and the launch of a new supervisory mandate that affects insurers by the Prudential Regulation Authority.

“It all means extra work for managers, but, jointly, the three sets of regulation should also make it easier for managers to identify gaps in their ESG capabilities and to establish a progression strategy for responsible investment,” says Connor Bigland, analyst, European institutional research at Cerulli Associates.

Pension funds should have updated their SIP policies to include an engagement policy as of October 2019, yet the introduction so far appears to have had little impact on pensions’ relationships with managers. However, Cerulli expects reporting on the enforcement of SIP policies, which begins in October this year, to begin to drive change. Research indicates that many UK-based defined benefit pensions are having to create engagement policies from scratch.

Cerulli believes that the question of how best to serve the engagement demands of individual clients within pooled investment structures is likely to resurface. 

“Initiatives such as Red Line Voting—an approach developed by the Association of Member-Nominated Trustees that sets minimum expectations that pension schemes can apply to investee companies—may provide solutions to the dilemma,” says Bigland. He advises managers to start developing and disclosing more sector and asset-class specific engagement guidelines.

Insurers, meanwhile, need to develop an approach to climate-related financial disclosures and introduce long-term scenario analysis. To do so they will need asset managers to provide more granular data.

Regarding scenario analysis, Cerulli expects insurers’ preferences to vary. Some will prioritise detailed reporting on the transition and physical risks; others will favour a range of scenario-testing metrics on their outsourced mandates. “For insurers with a greater capacity to produce bespoke scenario analyses, the preference will be for data. Because the risk profiles of insurers differ depending on the scenarios they provide cover for, others may be more susceptible to biases found in key climate forecast methodologies,” says Bigland.