Common Regulatory ESG Issues Facing Asset Managers

Around 530 million years ago, multicellular life burst onto the scene on Earth. Having been single celled for two billion years, this explosion of multi-cellular creatures became known as the “Cambrian Explosion.” In the evolutionary blink of an eyelid, life went from a few different types of single-celled organisms to a huge variety of diverse (and frankly weird) proliferation of sea-bound flora and fauna. Whilst the timeframes are completely different, it does feel that ESG investment capabilities are going through their own evolutionary “Explosion” event right now.

For years not very much happened in the ESG space, and now, not only has it become a huge investment theme in its own right, but it has also attracted a myriad of rules and regulations around it. Darwin’s theory of evolution talks very much about organisms being adapted to operate in the environment in which they find themselves. Those that are adapted best to their environment survive, whereas those that are not adapted perish. So, the environment in which asset managers must operate their ESG investment capabilities is set mainly by the regulatory frameworks under which they must operate.

As much of the multi-cellular life in the Cambrian Explosion has long since perished, so it feels like the asset managers who are not able to adapt successfully to the rapidly changing ESG regulatory environment of today (and the next few years) may also fall by the wayside. Perhaps either being forced or choosing to abandon ESG investing as a commercial opportunity due to the costs of remaining competitive, the lack of business inflows, or simply the failure to keep on top of the regulatory demands, in the ESG space.

The Regulatory Landscape for any asset manager pursuing ESG is complex for a number of reasons: -

Geographical Divergence - not all regulators are the same, and therefore, not all ESG regulation is the same. Asset managers find themselves increasingly grappling with multiple jurisdictions treating the same assets or products in different ways. Rules, standards, even timings all differ. This makes it hard for asset managers to juggle the complexity, particularly where they are a global organisation, having to keep up with multiple jurisdictional challenges.

Demanding Standards - Whilst regulatory guidance is becoming increasingly clear, many asset managers are now finding that the ESG regulatory bar has been set so high, that they cannot (with complete impunity) hold their hands on their hearts and say that their product or strategy meets the high demands of the regulator’s classification/categorisation. Indeed, some are actively walking away from trying to meet those high demands.

Rate of Change – the ESG regulatory landscape changes all the time. For example, the ISSB has attempted to standardise financial reporting standards across multiple jurisdictions (a laudable objective). It has no regulatory powers of its own, but regulators can adopt the ISSB standards. As of the time of writing, five jurisdictions have adopted these standards, and a further twenty are considering adoption. In all likelihood, any that are adopted in the future will come into force at various times. If ISSB standards were adopted globally tomorrow, it would be easy, but until they are, this is the type of state of flux that makes keeping up with ESG an issue at present. (Note that ISSB is just an example… there are others).

So can asset managers keep up with the current patterns of high divergence, demanding standards, and constant change within ESG regulation? Who will be the sponges, jellyfish, and anemones (the survivors), and who will be the Hallucigenia, Anomalocaris, and Marrella (the extinct) when the dust settles on the ESG explosion?