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(mis)Conduct, Money & Reputation
A series by reputation specialist Lansons Team Farner and law firm Katten. Join asset management experts David Masters (Lansons), Neil Robson (Katten) and guests as they dissect the top stories and misconduct cases across the industry, impacting reputation, brand trust and integrity.
(mis)Conduct, Money & Reputation
ESG, China & Investability
An increasingly diverse regulatory landscape presents substantial reputational challenges for investment managers.
Amid the shifting ESG terrain at the heart of financial services, investment firms are recalibrating their approach to sustainability, grappling with the balance between upholding ESG principles and avoiding regulatory pitfalls. If you're managing ESG related funds, you could now be fired by some of the very largest pension funds in the U.S.
Asset managers need to navigate an increasingly vocal anti-ESG group of asset owners, as well as the renewable energy investments in China, and the tragic impact of global conflicts.
In this episode, Katten Partner Neil Robson, Lansons|Team Farner Asset Management Lead David Masters and Lansons|Team Farner Sustainability Lead Sam Sharpe delve into the evolving sustainable investment challenges faced by asset and wealth managers whilst regulations and attitudes move in differing directions.
Recorded and produced at the Lansons Studios
This is Misconduct Money and Reputation. A podcast by reputation specialists Lansons and Law Firm Catton.
Speaker 2:Hello and welcome to the episode. This is our third episode in our new series for those working in financial services, particularly in and around asset and wealth management, where we seek to navigate a path through some of the more complex issues where regulation and reputation intersect. This is also the second episode where we're going to be looking at the concept of ESG, something which is, I think, important to us all, but also quite an evolving and dynamic area within the investment management world. I'm joined again by Neil Robson from Catton.
Speaker 3:Hello, thank you, david.
Speaker 2:And my colleague Sam Sharp from Lansons Team Farner.
Speaker 4:Hi thanks, David.
Speaker 2:The 26.6 billion Wyoming State Treasurer's Office has adopted a new anti-ESG language. The new statement mandates that fiduciary decisions be based solely on pecuniary factors that exclude the furtherance of environmental, social governance, political or ideological interests. Further, the statement condemns such criteria as having crippled, corrupted, disadvantaged, subverted, damaged or otherwise harmed the children, citizens, industry and financial well-being of Wyoming and America, and authorised the Treasurer's Office to take remedial steps should an investment partner behave in a non-pecuniary manner. So if you're an investment manager with a substantial assets under management being managed on behalf of the Wyoming State Pension Fund or similar pension funds across the US, you're now faced with quite a considerable dilemma. If you're managing ESG-related funds, you could now be fired by some of the very largest pension funds in the US, which has obviously massive impact on your revenue and massive impact on your business. Neil, I don't know what's the general state of play, do you think, in the US at the moment?
Speaker 3:It's a bit of patchwork and it depends on what colour the state is. So we've tended only to see Republican states making very sort of negative ESG statements. I mean, the prime example, of course, is Florida with Ron DeSantis, who Trump famously referred to as Ron DeSancdomonius who decided the top title black. Yes, exactly, but nonetheless Ron DeSantis, florida State Governor, has banned any of the Florida pension funds state pension funds from making any ESG-related investments.
Speaker 3:Again, it's that same sentiment as Wyoming that basically they must only ever invest on pecuniary factors. Basically, bottom line there is the investment has to be chosen exclusively because it will make money for the pension fund and no other reason. There can't be any suggestion that there's any environmental or social or governance factors taken into account, only that it's going to make money. And of course, let's not forget that with climate change, florida is the first state in the US that's going to disappear underwater, so it'll be too late by then anyway, but nonetheless, the fact is that we've got certain Republican states who have been banging the drum that ESG is bad for America, bad for America's children, and so on. And what's been interesting is that senior Republicans last December, in fact at Capitol Hill have accused big institutional asset managers of using their shareholder power to quote advance liberal goals, which is how they perceive ESG that you're a Republican, therefore you exist to make money and nothing else. That's their perception.
Speaker 4:It's all a bit 1980s.
Speaker 3:It feels a bit like it, doesn't it?
Speaker 4:Yeah, whereas it's interesting because then, if you look at some things that's going on, for example in California at the moment, where they're actually going I think Gavin Newsom has actually just signed it recently in the last couple of days where they've put much more extensive regulatory pressure on companies to disclose scope three for a start, which is incredibly knotty and difficult. They have to disclose scope three emissions. I think it's all companies over a certain size, both public and private, as well as then sort of their own version of TCFD. It's just incredibly interesting how polarized you're seeing some of this discussion and, of course, with California being the size it is, actually, the reality is that most US companies have some foothold in California and so it therefore, even though it's state legislation, becomes somewhat a de facto national way of looking at sort of climate and nature based disclosures.
Speaker 2:So I mean this is interesting, but it's also quite challenging, I would imagine, if you're a business trying to navigate this landscape where you've got very polarized views and you've got investors demanding ESG strategies, on one hand, and demanding that you, as the manager, are fulfilling your obligations as a responsible corporate citizen, and, on the other hand, you've got some of your largest allocators threatening to take money away from you if you do that. So I mean, sam, what would your advice be to some of these businesses in terms of how you might, you know, present yourself to the marketplace?
Speaker 4:If there's going to be two North stars that organizations think about around this, it's look at what the scientists are saying. We now have pretty much complete agreement on what's happening, so that is not going to go away. The problems we have to deal with and face and fix, largely through our financial systems, are very clearly established and agreed. The second thing I would say is that the lesson we've learned over the last five to six years I would say particularly since 2018, when I think is when we saw that real explosion in ESG, if you like, coming into the main markets is current.
Speaker 4:Current legislation and regulation has to be your lowest. Don't want to tell you always have to think of where the legislation and where the regulations are now as your lowest point and always look beyond them, because at the moment, even with all the legislation coming in from the SEC in California, everything that EU is doing it is still pretty Swiss cheesy. Over the next five years, I think those, those holes will significantly start to shrink and close up. So I would, my advice would be this isn't going away and the regulations will get tighter, so always look a step ahead.
Speaker 2:So when we think about the US, perhaps we also think about the US and its relationship with China. Now China presents in the investment management world with another substantial dichotomy it's the second largest economy in the world, it's one of the fastest growing economies in the world and there's also a lot of investment into renewable energy, whether that's through solar or wind or other forms of renewable energy. But on the other hand, they are, they present quite a challenge Human rights abuses. So we think about the genocide against the Uighur minority in the north north of China. We think about the lasting damage caused by the Great Leap Forward and Mao's revolution. Neil, what are the, what are the sort of challenges you see from, from, from your perspective, that China poses to global investors?
Speaker 3:I think you're right to refer to it as a dichotomy. I mean the fact that China still produces a huge amount of its electricity from burning coal. So the region of Inner Mongolia, which borders the country of Mongolia up in the far north, is a massive coal producing region. I was there some years ago and everywhere you go there's a black dust over literally everything. In fact, I was a backpacker at the time. I rode coal trucks hitchhiking around China. They burned coal to make electricity. Yet, of course, they've got an enormous electric railway network high speed rail Obviously a very buzzword here in the UK at the moment, but nonetheless they've invested in a lot of electric powered technologies.
Speaker 3:They have a huge investment in renewable, as you say. In fact, I believe that the world's biggest producer of photovoltaic cells. When you get out of the major cities in China, most houses have photovoltaics on the roof. They generate their own electricity, but yet, as you say, they've got on the S and the G. They've got some pretty big problems.
Speaker 3:Then, as an investor from the West outside China, if you think about, okay, who are you going to invest in? Let's just look at oh, nike trainers. Nike uses Uyghur slave camps to make its trainers in China. That was a major problem that burst into the press last year. Frankly, if you're an investor in Nike and you have an ESG or a social responsibility to your investment strategy, does that mean you've got a divest from Nike? The same goes for the likes of Primark, who were using children some years ago to stitch tiny sequins onto children's clothing in their Bangladesh factories.
Speaker 3:So these are really difficult and this really drills down into the corporate supply chain. Now the new EU directive on due diligence in corporate supply chains, I think, is going to help this in a big way. But ultimately also the supply chain point is a fundamental one, because if you're a business that's operating in some way from the UK, you're subject to the modern slavery act and again you have to look through supply chains to figure out who's doing what where in your supply chain. You can't turn a blind eye to it and you have to actively go through that diligence exercise to figure out who's doing what. Where does this component come from? Have we done what we need to to be able to say we've done the requirements, we've checked, we're comfortable that there's not, you know, slaves in the Middle East or in China who are making this stuff and we're getting it cheap. Let's turn a blind eye because it's so cheap.
Speaker 4:So what I was going to pick up on there was how you prioritize or have that debate around the EDS and the G, and whether you have to nail every single one or how you get the balance across all three within something, because I think something we hear quite a lot or have had the basket of years is, you know, the G has to come first. If you don't get that right, then the E and the S are somewhat irrelevant, whereas actually, on that principle, no one would have ever put any money into Tesla and actually look at the impact that's had from the E. So I think it's interesting how there are some aspects from a sin or a do-no-harm perspective when it comes to supply chain, that you absolutely are hiding factors across those letters, but then there are others where I feel it's you've got to dial it up and it's knowing where your priorities are or what's the most important and what you might sacrifice in order to do something really worthwhile, or perhaps that really influences an industry. On one particular of those letters.
Speaker 3:Yeah, and of course, the do-no-harm point is a really, really interesting one because that stems from the EU's SFDR, the Sustainable Finance Disclosure Regulation, which really drills down into the point.
Speaker 3:Are you looking at investments that do no significant harm, that don't damage principally the environment, based on that particular piece of legislation?
Speaker 3:But you could take that principle more broadly because, as we said in the last episode of the podcast series, esg doesn't mean exactly the same thing to everybody and in fact we have a patchwork or a mosaic of legislation around the world that big asset managers are going to have to try and figure out how to thread the needle and comply with all of them but do no harm to people, to environment, to the people you work with, society.
Speaker 3:That's quite a good way to think about this and it draws all the way back, I guess, ultimately to corporate social responsibility, way back before ESG was even a thing. But it's a challenge. Again, as we said in the last episode of the podcast, it's an incredible challenge for managers to figure out how do you get through this, how do you hold yourself out to the world. That sort of mission statement of this is how sustainable we're trying to be. Our ESG responsibilities are XYZ, setting forth what you truly believe in and then sticking to it, so that you're not in any way accused of prospectus fraud or manipulating your investors with false statements.
Speaker 4:Yeah, and also how you make sure that that becomes what those principles are, are entrenched all the way through the organization. I think that's another way we've seen organisations not quite get it right is where there is a bit of disconnect between what's happening and what's being said publicly at the top, between what every individual fund manager and person in comms ultimately believes or how they've interpreted those principles. So there's a lot of work to do in terms of joining all those dots.
Speaker 3:Absolutely.
Speaker 2:Yeah, we can't ignore China, because we're not going to mitigate climate change without the involvement of China. I mean, it's a practical impossibility, but it does. I think it does highlight some of the geopolitical challenges which ESG has become a central point around. When we think about these geopolitical issues, when we think about conflict in particular, what are the sort of key things that we need to be aware of?
Speaker 3:So I think it's a difficult one because I don't think a lot of people truly baked sort of global conflict war issues into their ESG sort of considerations in the past. We've lived through an almost unprecedented period of almost global peace in recent decades, with small flare-ups here and there. And, of course, if you look back, as we said earlier, under sort of corporate social responsibility and the exclusionary elements of investment strategies, you might have excluded certain armament sort of businesses alongside tobacco, alcohol, pornography, etc. But ultimately it's a difficult one because we, the West the UK, the US are providing arms to Ukraine to fight the Russians. In some ways, you might say this is again a proxy war. It's the West versus Russia, just as the scenario in Lebanon, with their decades of civil war, was the West versus the Islamic powers who were supporting the insurgents there.
Speaker 3:So I think it's really difficult. And to look at the context, of course, one of the problems we've had in the West is that with the Russian invasion of Ukraine, the West stopped buying Russian oil and gas. Obviously, there were sanctions in place, so we couldn't do that, but that triggered, unfortunately, a massive increase from the G20 nations in terms of investment into fossil fuels. So 2022 represented a peak of investment in oil and gas and coal, so it was 1.4 trillion, apparently, according to an article in the Guardian last year, which basically meant this was countries trying to find alternative sources of power because they couldn't no longer rely on the Russians. That's a bit difficult when you're saying that we, the investor, want to try and be sustainable and green, when we've got countries who are pouring money into CO2-emitting fuels in order to keep the lights on in those countries. So conflict is a difficult one and I think that ultimately, my view now sitting here, like 2023, is that I think a lot of companies have sort of got a social imperative to earn their license, the social license with the investors and the public.
Speaker 3:That seems to be growing. And if you just look at what's happened in the past two years unprecedented global temperatures September 2023, this year being the hottest September on record around the world. Temperatures of 25 Celsius in October that's ridiculous. Climate change is, I think, undeniable these days, notwithstanding what certain Republicans in the US might think. So extraordinary weather events you know, half of Europe on fire this summer. I think the let's say the message is getting stronger and stronger. And conflict is a difficult one because you know we stand with our allies in Ukraine against the Russian invasion. But if you say we shouldn't be investing in armaments, does that mean we're abandoning our allies? It's a difficult question.
Speaker 4:I think, to pick up on one angle of that in terms of the impact of conflict, I think it does. It does almost inject a dose of realism into what some of these investment decisions and strategies mean in terms of long-term security. I think we have to your earlier point. We have had this unprecedented period of peace, which we've all, frankly, taken a bit for granted. And now, if you look at the impact of climate change that we're likely to see so impact on harvests, on energy security, which we've seen acutely, very quickly through, which nobody really saw coming via Ukraine if you look at migration patterns and the impact that it's already having on politics within Europe and the reality is that is going to go up massively over the next decade so I think it's injecting a dose of realism into some of those strategies and policies because at the end of the day, that challenge, the sustainability challenge, doesn't go away, but life will always get in the way.
Speaker 4:So we have to build in that long-term thinking and I think we also have to get used to the fact that this is a to use an overused analogy it is a long-term marathon over the next 10, 20, 30, 50 years and there will be hiccups along the way. But as long as that long-term strategy remains in place, it can take the short-term hiccups where actually we do on a short-term basis. And I think we have seen this rollback slightly, or we've seen it. We have seen it balanced by increase by. You know, we have seen that initial pump of capital back into fossil fuels. We have seen that now balanced out by injections into renewable sources as part of that long-term strategy. But it's they have to work together.
Speaker 2:And it's not just that it was a, you know, a huge, lengthy period of peace, but also we have to remember that during that period, interest rates and inflation were at, you know, historic lows and you know the Russia-Ukraine war did not cause the spike in inflation. The spike in inflation was going to happen. The food shortages were going to happen. We were always going to have, we were having a drought in the US and it was always going to get worse because of the weather conditions. So the impact it had on grain supply, on fertilizers, et cetera, you know, have had this huge knock on impact on inflation, cost of living, which in itself has impacted investors' ability to invest. It also means that because most ESG assets are traditionally risk assets originally it was, it was all equity, increasingly these days, you know you can be an ESG investor through sustainable bond funds, through sustainable real estates, and you know, increasingly we're seeing impact in private markets. But you know if you can earn 5% or so on government bonds, you are therefore, you know you're able to earn a reasonable return quite safely.
Speaker 2:I think, therefore, that we are seeing we have seen a little bit of a slowdown in the flow of assets into ESG funds, but they are still growing and I think PWC have, you know, believed that the sort of total assets under management in ESG products will be somewhere just shy of 35 trillion by sort of 2026, which is only three years away. You know, and if you think about it, the what two or three years ago? They're about 18 trillion, so you can see that they will have doubled in about five years. The demand is still there, but there are increasing number of structural challenges for ESG investors and I just think, therefore, what does the future hold? So, neil, from your perspective, in terms of where do you think that the regulators are going? You know we've seen this direction of travel. You know, prove that you're doing what you're saying you're doing, etc. But what do you think are going to be the things that the regulators are thinking about or likely to be thinking about over the next few years?
Speaker 3:Well, I think that the direction of travel is clear and sort of the drip, drip, drip of new legislation around the world is almost exclusively focused on disclosure, disclosure, disclosure. Making sure that how you approach your investment strategy, what you're investing in, everything has to be very, very clear. Everything has to be disclosed in certain ways. Okay, they're going to differ from country to country. I think the likelihood of harmonisation between US, uk and EU rules is remote, to say the least. You know, we've got UN standards, the PRI, for example. These are all very, very different and, as I've referenced in the past, this is a mosaic or a framework of all sorts of different things that you have to adhere to.
Speaker 3:But what's coming next is, I think, there'll be a lot more greenwashing, enforcement action. It's a lot more, I think, of what we've been seeing a little bit of. That's going to become much bigger. So, lots more enforcement, lots more focus on. You said XYZ on your website and you didn't do it. Well, that's false advertising. That's, you know, market manipulation in the sense of you're promoting a product using something that's inappropriate or wrong. So I think that's sort of where I see it going.
Speaker 4:Yeah, I would add to that that I think people have to be at peace with the fact that this is not going to get internationally aligned or simpler. No, it's only going to get more complicated. I think we have this pre-inbuilt theory that things get better and more simple and we get our heads around them. Actually, on this issue, as we put some debates to bed, others are going to emerge. Like, as we get comfortable with some regulation and technical concepts, we're just going to explore and realize the nuances within those that then make it take it in other directions.
Speaker 4:You know even things like NDCs, which will be at the forefront during this COP. We don't even internationally agree on what should be in and what should be out. We don't even agree as a country, I think you know it was a really simple concept five years ago when we needed to put some value on it. Now, as we've used it, that becomes more complex and I think we'll see that across the board, particularly with regulation. I think there's no point in waiting for the US and the EU to be aligned, because it's not going to happen.
Speaker 3:And, as we said earlier, this is a political football. You know different countries have different approaches. You know the US Republican versus the universe. You know, even with the EU taxonomy regulation, trying to figure out what is actually truly sustainable in terms of, say, an energy source is nuclear safe and is it sustainable? Well, you've got thousands of years. You know the half-life of uranium is 2,000 years. You have a waste product that's going to be around for hundreds of generations. Should that truly be considered a sustainable energy source? What about, you know, biomass or electricity production plants in Scandinavia that burn trees? Well, trees are renewable if you keep planting them, but then that's just putting CO2 back in the atmosphere that you took out the atmosphere over the last 20 years.
Speaker 3:So it's an absolute football, a political football that is going to get kicked around with people having different agendas. It's going to be a challenge and staying on top of it is going to become a full-time job for a very large group of people. And if you think about the evolution of business, you know when I was a kid, human resources was not really a thing, Health and safety was not really a thing, it was just be sensible and do the right thing. These whole sectors of you know large numbers of people working in industry. You know health and safety. Every business has to be focused on that. You have to have an HR team. Having an ESG-focused team who understand exactly what the business is doing and saying is going to become an absolute imperative.
Speaker 2:But I think what we're agreed on here is that you know, whatever we call it, whether we call it sustainable investing, sustainability, ESG impact it's around here.
Speaker 2:It's here for the duration.
Speaker 2:There's definite ongoing demand for investors to want it.
Speaker 2:I suspect that it will evolve from an investment perspective and that what we have now, where you know we've moved to this sort of ESG integration, the impact type investing where you're investing for things like intentionality and additionality will become much more than norm directed towards public markets as much as they are currently towards private markets, and that that will be the way, the mechanism by which a lot of investors, institutional and otherwise, will ultimately be able to see their values at work or their capital put to work in a way that is aligned to their values.
Speaker 2:So I think, but I think there is a long way to go between then and now, and I think the politics of it, the regulatory divergence, I think, will be challenging for a lot of businesses, and obviously there are other things going on within the asset management industry. But, Sam, I think, as our guest, we're going to hand over and give you the final word. So what's your thoughts about the sort of? You know? What's your last word on the way that the world of ESG is developing? How do you see the future?
Speaker 4:I think it's only going to get more embedded, more important and more incorporated into everything we do and, even though I think the politics of it is getting more polarised, I think we are seeing shifts in which it's being embedded in a more long term way, like if you look at what Biden's doing with the IRA, it's harder to roll back. It's becoming much more entrenched in the way our economies work and how we think about growth and how we think about jobs, and it's not going anywhere, sam thank you very much, neil.
Speaker 2:Thank you, I think that is all we're going to have time for today. We will be back next time where we'll be exploring further areas where reputation and regulation intersect in the world of asset and wealth management. Do check the show notes for links to some of the things we've been talking about today, and if you do have questions or you've got suggestions for future topics, then do get in touch at studiosatlansonscom. Thank you very much. I'm David Masters, I'm Neil Robson, I'm Sam Sharp and thank you for listening.
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