This article is produced by CMS Holborn Asia, a Formal Law Alliance between CMS Singapore and Holborn Law LLC.
The Monetary Authority of Singapore (MAS) recently announced that it would deploy US$1.8 billion to five asset managers for climate-related investments as part of its broad objective of building a climate-resilient reserves portfolio. These asset managers will in turn establish their Asia-Pacific sustainability hubs in Singapore, and launch environmental, social and governance (ESG) thematic funds in the region.
The big picture
The MAS’ recent commitment is part of its broader objective of promoting sustainable finance. This announcement coincided with the release of its inaugural sustainability report, and builds on its issuance of guidelines on environmental risk management for financial institutions in December 2020.
What is ESG?
Despite the growing interest in ESG investing, there is presently no real consensus on what qualifies as an ESG-related investment. Yet this has not deterred investors, who have demonstrated strong demand for so called “ESG funds”. Assets under management in ESG funds globally have grown from US$10 billion in 2015 to US$246 billion in March 2021, and will no doubt increase.
Although the MAS has previously encouraged fund managers operating in Singapore to launch more ESG and sustainable funds, it has not provided guidance on what it envisions ESG investing to be. The exact mandate of the MAS-backed ESG funds also remains unclear. However, the MAS has indicated that it is looking to allocate more investments to actively managed strategies that seek out climate change-related opportunities, or tilt investments towards more climate-resilient companies. This suggests that the MAS’ approach to ESG investing places a greater emphasis on the ‘E’ in ESG, and may be narrower than some ESG indexes (such as the FTSE ESG Indexes) that issue ESG ratings based on a company’s management of ESG issues.
Why does this matter?
As counsel to both fund managers and investors we see both sides of the challenges and opportunities that ESG investing present.
For investors, it can be tough to verify a fund manager’s ESG credentials and even harder to properly monitor ESG compliance post-investment; how do you stress-test a fund’s ESG policy over a period of years and how do you exit if the fund falls short?
The divergence in approaches to ESG investing means that investors looking at ESG-focused funds ought to carefully review such funds’ methodology for selecting investments. Relatedly, in the retail space the increased interest in ESG investing has led to increasing numbers of ESG exchange traded funds (ETFs) that are constructed using a wide range of different methodologies. Proper scrutiny of these methodologies is required to ensure that investors are in a position to select managers whose approach to ESG investing is aligned with theirs. It is worth noting that even though a fund purports to be ESG-focused, the core businesses of its underlying investments may not necessarily be related to the environment or sustainability. To illustrate, the top 5 constituents of the MSCI USA Extended ESG Focus Index are Apple, Microsoft, Amazon, Facebook, and Alphabet.
Investors also ought to be clear about their reason(s) for ESG investing. While the MAS’ main reason for climate-related investments is to build a climate-resilient portfolio, others are driven by the prospect of delivering better returns from ESG compliant investments. The jury is still out on this hypothesis - a recent study by Scientific Beta suggests that ESG strategies do not significantly outperform the market when adjusted for quality factors (such as profitability). For many institutional investors however regulatory and reputational pressure means that ESG factors now sit high on the “must haves” for any fund investment; but for this to have meaningful sustainability impact it needs to amount to more than a box ticking exercise.
For managers, the same reputational challenge applies so those managers that can build and maintain a reputation in this space should reap the rewards of greater commitments and more funds under management. How closely managers want to align their own performance and remuneration to ESG compliance remains a key question; in the case of funds that are actively marketed as “Green Funds” it is now fully expected that failure to meet sustainability key performance indicators will hit performance fees.
For smaller managers, particularly in the venture capital (VC) space, the costs associated with ESG compliance can be significant. We see VC managers doing better on the ‘S’ and ’G’ of ESG as these are driven by the intrinsic culture of the manager. For VCs the ‘E’ could be seen as less relevant to early stage investments, but equally harder to satisfy. The recent focus on the environmental impact of cryptocurrencies shows, quite rightly, that climate concerns are relevant across all sectors and asset classes.
Where do we go from here?
The increasing focus on sustainable finance and sustainable investment is here to stay, and the industry must adjust accordingly. The MAS will consult the industry later in 2021 on mandatory climate-related disclosures by financial institutions, although it already expects financial institutions to make climate-related disclosures from June 2022 in accordance with well-regarded international reporting frameworks, such as the Task Force on Climate-Related Financial Disclosures’ recommendations.
This foreshadows an approach similar to that in Europe. The Sustainable Finance Disclosure Regulation came into force on 10 March 2021 in the European Union, and requires fund managers (and other market participants) to make enhanced disclosure of various sustainability investment issues.
Singapore often looks to other jurisdictions to learn from their “best practice” in the fund management sector and we will be tracking what mandatory sustainability disclosures may emerge in Singapore.