Responsible Investment- the IA's Framework for a Common Language

On 18 November 2019, the Investment Association released its Responsible Investment Framework Final Report the “Report”).

The Report follows the IA’s consultation at the beginning of this year, which sought industry views on:

• a proposed framework to categorise and define common Responsible Investment approaches (the “Framework”);
• a UK retail product label for funds which use Responsible Investment strategies; and
• investment managers’ use of disclosures and sustainability indicators.

Each of these topics is covered in the Report (with the focus very much on the suggested Framework), and is discussed further below.

CMS perspective: Why do we need clarity around Responsible Investment?

As climate change has finally become a crucial political topic across the globe, the public now focus on the climate impact of large financial institutions. Responsible Investment is no longer a choice or the hot topic of the day – it is now mainstream, and a reputational imperative for our clients.

There are two main issues:

• a fundamental lack of understanding of what Responsible Investment is and how the wide range of strategies are applied: it is not all about climate change and positive impact. As an industry, we must demonstrate that there is no right and wrong answer with Responsible Investment. It is an incredibly broad spectrum. Key to this is clarity and consistency of language, and transparency of disclosure.
• fund houses must understand the impact their approach to Responsible Investment (or not) can have on public perception. It extends to the whole business, not just to fund strategies. Helpfully, the IA have addressed both firm and fund level components in their report. Fund houses must consider their approach to Responsible Investment holistically. This should be a top down approach which clearly articulates the firm’s purpose and strategy. Without this, there is a high risk reputational damage.

The Framework will not be enough to fix the issues which exist, nor is it intended to. Houses need to consider the totality of the law, regulation and guidelines which apply to Responsible Investment activities and take appropriate steps to manage risk and harness opportunities. The Framework is, however, a helpful step forward.

What have the IA proposed today?

1. The Framework - categorising and defining responsible investmentThe Framework is intended to provide a common language to define Responsible Investment approaches – bringing clarity and consistency to the way the industry defines key terms. In turn, this should make it easier for investors to understand what their funds are doing in an area which is immensely varied and, at times, very subjective. What is the Framework? The Framework is a high-level reference point, supported by a set of definitions. The definitions helpfully refer to existing terms (eg those of the UN Principles for Responsible Investment) to avoid over-complicating an already fairly cluttered landscape. Crucially, the Framework distinguishes between firm and fund level approaches. Clients must understand the impact of Responsible Investment across their entire business, and determine how to address this separately from their funds.

• At a firm level, the IA distinguish between: Stewardship, ESG integration and Exclusions.
• At a fund level, the distinction is between: Exclusions, Sustainability Focus, Impact Investing, Stewardship and ESG Integration.

At each level, the IA provide examples, representing the broad spectrum of activities that could fall into each bucket. These categories are not mutually exclusive and may represent different parts of a firm’s overall approach to Responsible Investment.

How should you use the Framework?

The IA does not propose that the Framework be a standard to cover all aspects of a Responsible Investment strategy. It has three proposed uses:

• Provision of a common language to allow managers to better explain how they deliver Responsible Investment and contribute to sustainability. The IA consider it a tool to allow firms to articulate their strategies in a consistent manner.
• To allow the IA to collect data on the use of Responsible Investment in the industry. From January 2020, the IA will be asking firms to denote which of their funds have such characteristics, with the IA looking to publish statistics later in 2020. The IA will also be collecting data on segregated mandates and firm level implantation for its annual survey in 2020.
• As general guidance for managers, allowing them to develop their disclosures, policies, and strategies with consistency.

• UK retail product label

The IA is considering introducing a product label for UK retail products, to help investors quickly understand whether a particular fund follows a Responsible Investment approach. The IA also considers that such a label would help to draw attention to the UK as a leader in Responsible Investment.

At this stage, although the report confirms wide industry support for a label (85% of firms responding to the consultation), exploring this option will be part of the IA’s continued work on Responsible Investment through 2020. There are no more concrete details in today’s report.

We would encourage clients to engage with the IA on this topic to ensure any label is both inclusive and flexible enough to cover the wide range of possible Responsible Investment strategies. As with the EC’s proposed taxonomy, it is imperative that labels and definitions allow for continued innovation and do not appear to favour one strategy over another.

• Disclosure of sustainability indicators

The final part of the IA’s initial consultation aimed to achieve a clearer view of how managers use existing frameworks to disclose:

• how they integrate ESG into their investment processes; and
• how they report against indicators such as the UN SDGs.

Again, there is much inconsistency on disclosure in the market. However, the landscape here is changing – particularly with the coming impact of the EC’s Sustainable Finance Package and the requirement to make detailed ESG disclosures. Yet, data against which to report remains limited and inconsistent.

The IA recognise that despite progress in this area, there remains a significant challenge for the industry and for policy makers because many voluntary frameworks exist and reporting is not consistent. Again, the IA are looking to continue their work in this area but today’s report does not give a clear indication of where this might lead.

An important next step in this area will be ESMA’s expected consultation on sustainability indicators and the disclosure of adverse impacts. We would encourage clients to engage as much as possible with all consultations in this area.

Next steps

The Framework is a voluntary guide to assist with the creation of a more unified language within the industry. You may wish to:

• consider how to implement the Framework in line with your current fund ranges, and also how to use it to develop your firm wide strategies.
• gather information in preparation for the IA’s request for data from January 2020

However, the Framework cannot be viewed in isolation and clients must also be aware of all other upcoming laws, regulations and guidelines which will require attention.

The IA confirms it will be continuing its work in this area, including the publication of the statistics referred to above, as well as establishing a working group to consider the use of Responsible Investment in fund documentation, reporting on sustainability and further exploration of a product label.

How can CMS help you?

We have a number of Responsible Investment experts within our funds and investment management teams. The correct implementation of a Responsible Investment strategy, at both firm and fund level, is essential from a reputational perspective and crucial for the continued success of fund houses within the sector.

We are assisting clients globally on the development of integrated Responsible Investment strategies, implementation of these strategies throughout the business, and ensuring appropriate disclosures are made. We are very well placed to assist with any changes that you may wish to make to your internal policies and fund ranges to account for the Framework and to help you understand how to develop your disclosures, within the Framework, to maintain your own Responsible Investment purpose.