Green Finance Advisor of Friends of the Earth (HK)
Financial markets are based upon a framework of financial reporting where market participants can determine whether one security is more attractive versus another, and on the whole be able to allocate capital to its most efficient use. The framework relies on standards maintained by bodies such as the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB), coupled with commonly accepted valuation methodologies such as the discounted cash flow and relative valuation models, markets are able to determine with some accuracy which securities will receive the most favorable funding rate, and thus lower cost of capital.
The same could not be said about Environmental, Social, and Governance (ESG) investing, and yet this very standardization is the key to making companies behave responsibly, as it enforces a real cost to companies should they be less well rated than their peers in ESG factors in the form of higher required rates of return. There have been attempts towards standardization of Responsible Investment (RI), and we should now be familiar with the United Nations sponsored Principles for Responsible Investment (PRI), first launched in 2006. However, while the PRI sets the tone towards responsible investing overall, it may lack detailed implementation guidelines for specific segments of the market for it to be applicable. Under the auspices, in March 2021 the Standards Board for Alternative Investments (SBAI is an international standard setting body for the alternative investment industry and sets the voluntary standard of best practices and practices endorsed by its members) launched its own Responsible Investment Policy Framework specifically helping alternative asset managers to document and demonstrate ESG investing with clear standards.
Broadly, the policy framework provides guidance on the following:
Integration of RI-related factors into investment processes, where financially material, is a growing expectation by allocators. The key distinction between this and other RI approaches is that RI factors are not used to pre-define an asset universe. (SBAI RI Working Group, 2021).
RESPONSIBLE ASSET SELECTION
Exclusion and inclusion are not mutually exclusive and some combination of the two may be used as an RI Approach. Impact investing with the specific goal of delivering meaningful societal or environmental outcomes is growing in popularity. It requires clear and measurable impact goals, such as alignment with the UN Sustainable Development Goals. (SBAI RI Working Group, 2021).
RESPONSIBLE ASSET OWNERSHIP
Voting can be a key part of an approach to RI. Managers should have policies on how to vote on matters directly related to RI. Engagement has traditionally been viewed through a direct lens where managers attend company meetings where they can push for change. Managers outside of these strategies can approach engagement at a more holistic level by engaging with regulators, exchanges, and industry organizations such as the SBAI. (SBAI RI Working Group, 2021).
RESPONSIBLE CORPORATE AND MARKET CITIZENSHIP
Being a responsible investor is not limited to the investment process. There are many other ways that managers can demonstrate commitment to RI-related goals. This may include organizational initiatives to address environmental, social, and governance issues. Firms should also consider their behavior in and impact on the market to ensure that they contributing to reliable and fair markets. (SBAI RI Working Group, 2021).
GOVERNANCE, MEASUREMENT, AND DISCLOSURE
This process starts with defining measurable goals to monitor the product in relation to the stated RI objectives. This may include benchmarking or tracking of ESG ratings in the portfolio over time. Oversight of the process will be key to governance and may require specific knowledge and understanding of the issues; therefore, training (or the hiring of experienced talent) will likely be required. Disclosure to investors is also critical. It is becoming a minimum expected standard for managers to have a detailed RI policy in place. The level of detail required in a policy will be dependent on a number of factors such as whether the product has an ESG focus or not. The SBAI Toolbox memo provides a detailed framework of the types of disclosures that should be included within an RI Policy. (SBAI RI Working Group, 2021).
this is by no means a comprehensive measurement standard such as those set by
IASB and FASB, it is still a move towards more standardization in the
responsible investing quest. As each market segment comes up with its own
applicable and implementable standards, this blog post certainly looks forward
to a global standard in the realm of responsible investing that is as robust as
those promulgated by the accounting standards setting bodies.
- SBAI RI Working Group Working Group (2020), “Review of Responsible Investment Regulatory Expectations”, Standards Board for Alternative Investments, https://www.sbai.org/wp-content/uploads/2020/10/ToolBox-Memo-Responsible-Investment-Review-of-Regulatory-Expectations-Final.pdf
- SBAI RI Working Group (2021), “Responsible Investment Policy Framework”, Standards Board for Alternative Investments, https://www.sbai.org/wp-content/uploads/2020/10/SBAI-Toolbox-Memo-Responsible-Investment-Policy-Framework.pdf
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