Chris Fidler, Senior Director for Global Industry Standards, outlines the CFA Institute’s plans to ease due diligence efforts of asset owners.
The CFA Institute’s plan to roll out global ESG disclosure standards for sustainable investment products in May 2021 is fully on track. Chris Fidler, Senior Director for Global Industry Standards, is optimistic the voluntary initiative could be incorporated into regulatory requirements in some jurisdictions.
The CFA Institute, a global association for investment professionals focused on standards and education, announced its intention to develop the standards last August, with the aim of boosting transparency and reducing investor confusion in the booming ESG investing market. If successful, they will “facilitate better alignment” between the sustainable investing objectives of the investor and the ESG features and characteristics of the investment product.
The overall approach is to provide guidelines for fund providers to standardise the kind of upfront information that an investor would need when choosing a sustainable investment product. In the consultation, the CFA Institute took established categories for funds within the ESG investing space – such as integration, exclusion, best-in-class, thematic, impact and engagement – with the aim of defining the disclosures needed by investors for each.
“The goal of the standard is to have disclosures that are complete, reliable, truthful, accurate and consistent,” says Fidler.
Risk of duplication?
It hasn’t all been plain sailing. Sceptics have been few in number, but not without influence. As the consultation period closed last October, it became clear that some parties felt the planned standards would add to an already crowded field of disclosure and reporting frameworks. Some respondents felt there was overlap with the European Sustainable Finance Disclosure Regulation (SFDR), which requires asset managers selling funds in the EU-27 to publish information to help investors compare and assess the sustainability characteristics of their funds.
The US-based Investment Company Institute, which represents fund providers, worried asset managers were being asked to “navigate an increasingly crowded field of duplicative, overlapping or conflicting legal requirements”. European asset manager Candriam said there were risks of additional costs and confusion, while US-based asset management group Securities Industry and Financial Markets Association suggested national regulators should take the lead on disclosure standards.
But Fidler says feedback has been “overwhelmingly positive”, with approximately 90% of respondents to the consultation backing the need for a global standard to help investors better understand and compare the ESG-related features of investment products and agreeing on the suitability of a disclosure-based approach. Only six of the 100-plus responses (totalling 3,000 comments on the 44 questions contained in the consultation proposals) from more than 30 countries were critical in the effort, says Fidler.
Letters came from a broad set of respondents: as well as asset managers and investors, a range of advisors, associations and regulators also contributed. BlackRock’s submission said a robust and widely accepted disclosure framework for ESG investment products is critical to avoid ‘greenwashing’. But the world’s largest asset manager said the CFA Institute should “carefully monitor” the regulatory landscape, “as any final standard will need to align and avoid duplication with regulatory standards”.
Overlaps ‘no bad thing’
Since the consultation closed, the CFA Institute’s technical committee has been analysing the responses and will now embark on the task of developing an exposure draft, i.e. an initial version of the requirements and recommendations as they would appear in the standard.
Fidler says the CFA Institute is now more confident than ever that standards are needed. “It’s important to keep some scepticism about your own efforts, and continually check that they’re needed. The responses were a good data point that reaffirmed the need for this standard,” he says. “Over the past six months, we’ve got a more granular view of where this standard would overlap appropriately.”
According to Fidler, overlaps between the CFA Institute’s planned standards and requirements of local regulations are “not a bad thing” per se, asserting that global principles can complement national rules, which necessarily must take account of factors specific to their jurisdiction.
“Part of what we’re trying to do with a global standard is to ‘commonise’ some of the practices for disclosure that are done locally. There are some big differences right now in different jurisdictions about the extent and nature of disclosures for these kinds of products.”
The CFA Institute’s standard will and should overlap with SFDR, for example, as Europe has gone the furthest in specifying the type and nature of disclosures that need be made to support the sustainability credentials of investment products. “In other jurisdictions, there is none,” he notes.
Inevitably, situations will arise in which local regulations require certain disclosures not covered by the standard, and vice versa. “That’s OK,” says Fidler. “The goal is always to work toward greater harmonisation, because that’s how markets work most efficiently. There will always be issues where different jurisdictions value different things. There’s space in the world to operate in harmony, even if there are differences.”
Simplifying due diligence
Fidler says the experience of the asset owner looking to select from the roster of sustainable investment products is currently more difficult than it should be. “There is a lot of variation in the extent and nature of disclosures (by asset managers on ESG products). Even if you know what you want, it’s frustrating trying to get information and evaluate it on a level playing field. We’re looking to make it easier for the asset owner to do that comparison and have greater confidence that what they’re investing in really does align with their investment policy statement.”
Due diligence questionnaires from investors can today run to more than 100 questions, he notes. Further, similar questions can be asked in vastly different ways, potentially eliciting slightly different responses. The resulting process is time–consuming for the asset manager and not always illuminating for the asset owner.
“With the standard, we’re trying to take a lot of that information and say: here’s what you describe upfront,” says Fidler. “It is not going to answer every question, but it will offer some more standardisation around the process so that we don’t have to ask so many questions. Through standardisation of disclosure, the information will be out there and can be more easily collected by databases and product platforms.”
Although the standards aim to cut out much of the legwork currently required to assemble and analyse information across competing products, there is a recognition of a variety of needs and circumstances among asset owners. Individual organisations will attach different weights to the design and track record of a particular product, for example.
Fidler also notes that the importance of firm- and fund-level information can differ across investors and circumstances. “If you are an institutional asset owner with a mandate for a bespoke product, you may assess the company first, trusting that they can build a specific product, not unlike picking a builder for a custom house. But that investor, for a different part of their portfolio, might need to buy something off the shelf,” and as such would be more focused on the product than the entity.
Scope of standards
The main body of the planned requirements will focus on the content of fund-level information on sustainability provided to customers. “At this point, we’re really focused on the product’s objectives, constraints, policies and methodologies,” says Fidler.
At first at least, this means concentrating on pre-contractual disclosures, rather than periodic reporting, “Both are really important, but for this first version, we’re not going to bite off more than we can chew. We’re therefore going to focus on the pre-contractual [information], because that really sets the stage.”
Today, investors often find there is a lack of clear distinction between different types of sustainable investment products, which can lead to confusion over the alignment of a fund’s overall objectives and its underlying components.
“Is it appropriate for a fund to have some coal in its portfolio? You’ve got to know what its objectives are. We’re starting with that set of disclosures. Later, there is still the opportunity to establish some standards for ongoing reporting,” Fidler says, suggesting that areas such as proxy voting or engagement could also benefit from some additional standardisation.
Investors often find environmental laggards or underperformers lurking within funds, leading to suspicions of ‘greenwashing’. But while a carbon–intensive heavy emitter might not be suitable for a best-in-class ESG fund, its inclusion would make more sense in the context of funds looking to identify firms in the midst of a turnaround story, about to embark on a transition to lower fossil fuel usage.
“That’s why you can’t look at holdings in isolation,” says Fidler. “You have to compare the holdings against the intention of the strategy. In terms of defining types and categories, it’s never really been our intention to label things. It’s about giving investors assistance in going from their needs to selecting a product.”
Not a labelling exercise
As such, the CFA Institute disclosure standard will not set out criteria for what is or is not an ESG product, or what can or cannot be labelled ESG integration. “Different markets have different needs around those things. It’s appropriate for regulators to make rules around naming and categorisation. We’re going for disclosure of information.”
Einstein famously said, “Everything should be made as simple as possible, but no simpler”. This maxim seems to inform the CFA Institute’s approach to the sustainable investment product universe and outlining the relevant disclosures. Put simply, if a product has or does X, it will need to disclose Y.
“If a product has a preference, for example, for investments with positive ESG characteristics, then tell us about those preferences and characteristics, and how are they being measured. That’s more informative and relevant,” says Fidler.
“Everyone wants to make it so easy that they could understand via a quick label,” he says. “That’s human nature. But these are complicated products. I don’t think it’s so easy to just slap a label on and then everybody’s clear. If a food product is labelled natural or organic, it’s sort of helpful but there’s still a lot of debate about what those terms mean.”
General principles will be laid out within the standard, including a need to keep information current. Because the goal is to get the information to investors, there will be requirements for distribution, which will include options. The CFA Institute will not mandate any particular mechanism or channel, recognising the use of different methods across markets and client segments.
Advantages for managers
As noted above, there are some concerns the introduction of a new disclosure standards framework for ‘green’ funds has the potential to increase compliance costs in an already squeezed industry. Fidler says that initiatives to provide greater clarity and transparency to customers will be beneficial to the standing of the investment management industry and the financial services sector more generally.
“When people abuse positions or make exaggerated claims, then people lose trust in the industry, which can undermine relationships and ultimately lead to more regulation. It’s better for the industry to take responsibility and show that they are self-regulating and doing the right thing,” he says.
As well as bolstering trust, standards enable firms to compete on a level playing field, says Fidler, drawing parallels with the CFA Institute’s Global Investment Performance Standards, which have helped to establish a comparable basis for fund performance over time horizons. “If you’re good at what you do, you want a level playing field so that your product and its performance can speak for itself,” he says.
Fidler is positive about the prospects for the CFA Institute’s standards being adopted by regulators in markets that do not have disclosure frameworks in place. “I’d be very pleased if regulators in those jurisdictions felt that the standard was world class and appropriate for their jurisdiction. I’d be happy if we made their job easier,” he says.
But he notes that adoption of the standard in mandatory rules is not the only value of the standard to regulators, suggesting the scope for jurisdictions to use just some of the most applicable requirements, or perhaps adopt certain principles, if in a principles-based regime. The CFA Institute has already spoken to several regulators already. “They recognise that our interests are aligned. While they have the power to create mandatory rules, those are limited by their jurisdiction. So, they see the value in having common rules that span borders. Each perspective enhances the other,” he observes.
Initial conversations with regulators have included those in the US. Fidler hopes that the release of the exposure draft in May will give US regulators a sense of the scope of information necessary for investors to understand ESG products. “I just hope it will feed into their thinking one way or another,” he says.
Given the rising popularity of ESG-focused investment vehicles and the number of new launches in the sustainable investment space, Fidler says it is possible that a broad swathe of investment products available to investors could end up being described using the CFA Institute’s standards.
“Now, the majority of investment managers offer some type of product that embodies something covered by our standard, be it an explicit objective, incorporating ESG data, or having some kind of preference or focus. I think the take up is going to be wide and I would hope it would be equal to our other voluntary standards.”