A key challenge for fund managers is the difficulty of demonstrating the impact and results of the ESG product in practice.

By Sivananth Ramachandran and Mohan Kumar Prabhu

Investors have defined financial objectives in terms of return and risk, time horizon and liquidity. Increasingly, they also want to express their ESG preferences, ranging from the need to incorporate ethical principles or values ​​into investment decisions, to avoid ESG risks that could affect investments, or to contribute to achieving measurable environmental and social outcomes.

In response, the investment management industry has developed products that incorporate a variety of investment approaches to consider ESG issues. However, investors face several difficulties in selecting the right ESG products to suit their preferences. These problems range from the diverse and non-standard terminologies in investment products to the lack of clearly defined categories into which these products can be classified.

These factors have led to an increase in greenwashing, where disclosures or promotional materials intentionally or unknowingly mislead investors about the ESG characteristics or the ESG approaches used in an investment product, or the degree of influence an investment product has on ESG issues.

There is no one-size-fits-all solution to this, but good ESG publications are a starting point. Effective ESG disclosures help improve investment efficiency and enable investors to ensure ESG regulations are consistent or true to their label with regard to their stated objectives, documented investment policy and strategy. Accordingly, better ESG information for investment products is quickly becoming a top priority for financial market participants and regulators worldwide. While multiple ESG disclosure frameworks are emerging through various global standards bodies and regulators, there are still no universally agreed standards or disclosure frameworks used by all fund managers worldwide.

Given the increased activity in ESG investing in India, SEBI recently published a consultation paper on the introduction of disclosure standards for ESG Mutual Fund schemes in India with the aim of protecting the interests of investors and market participants and addressing issues of ESG greenwashing. funds in India.

A study conducted by the CFA Society India compared the recommendations of SEBI’s consultation paper with international regulations such as the SFDR and voluntary initiatives such as the CFA Institute’s ESG Disclosure Standards for Investment Products and found that the recommendations align well in most respects. However, international standards can provide a level of detail that is complementary to SEBI’s proposals. For example, for best-in-class screening, SEBI’s proposals require fund managers to provide “details and particulars of the statistics used.” On the other hand, the CFA Institute’s ESG disclosure standards require fund managers to disclose, among other things, the characteristic of the investment being evaluated, the thresholds used, or any exceptions. There is also reason to better structure SEBI’s proposals in terms of company level, product level and periodic disclosures. Finally, recommendations regarding practices, policies and procedures should be clearly distinguished from requirements.

Despite the bickering, the more pertinent question is whether the fund managers in India are currently equipped enough to set up such corporate-level policies and ESG-related product information? In a recent roundtable convened by CFA Society India, market participants highlighted several challenges and practical considerations in implementing some of the proposals in SEBI’s consultation paper.

A key challenge for fund managers is the difficulty of demonstrating the impact and results of the ESG product in practice. Most funds consider ESG risks and opportunities when creating investment portfolios, but do not consider the impact of portfolio companies on the environment and society. Even if the two are linked, it is easier for fund managers to report on the former than on the latter. SEBI itself recognizes this distinction in its recent consultation paper on ESG ratings, where it distinguishes between ESG risk assessments and impact assessments. ESG risk assessments relate to the impact of social or environmental issues on the enterprise value of the company, and the impact assessments relate to effects in the other direction.

The second challenge raised by the participants is the potential duplication of disclosures, especially around stewardship reporting. The proposal for fund managers to report on stewardship and commitment to any ESG product is substantial and may increase the compliance burden. This is because stewardship reporting is currently done at the fund house level, and if a fund house has multiple funds, issuer involvement is not different between funds.

The proposal to make BRSR listings, which are mandatory for the top 1000 Indian companies, mandatory for inclusion in ESG funds also raises interesting questions. Should the regulator in principle prescribe how fund managers compose their portfolios, or should they focus on transparency and better disclosures? On the other hand, ESG funds are given the flexibility to apply ESG considerations only to up to 80% of their investments. Investments outside of the top 1000 companies, which are micro-caps, are likely to be very small, making this rule offside. Still, regulation should provide fund managers with the flexibility to use discretion and judgment, whether it’s a company’s ESG factors, or more generally how they build portfolios, while staying within their investment mandate and applicable rules.

ESG disclosures worldwide provide a foundation for investors and advisors to evaluate products, understand which products may be appropriate given their (or their clients’) ESG preferences, and invest (or recommend) accordingly. But the penetration of investment advisors in India is minuscule, and the ESG disclosures are presented in the comprehensive information document on the scheme. Therefore, the role of fund managers becomes paramount. Fund managers must provide ESG information in a simple, relevant and decisive manner in their factsheets or other promotional materials. They should also invest in investor education that focuses on material ESG risks considered in portfolios, how ESG products might perform in different market scenarios, and the desired time horizon for investment. And given the nascent stage of ESG investment in India, regulators and policymakers would do well to refrain from overly prescriptive rules, both around investing and disclosures, which could lead the industry to a homogeneous set of players, leaving little room for maneuver for further innovation.

(Sivananth Ramachandran is CFA, CIPM – Director, Capital Markets Policy, India at CFA Institute. Mohan Kumar Prabhu is CFA, FRM – Director, Investment Consulting at AON Consulting Private Limited. The views expressed in this article are those of the authors and not necessarily from FE.com)


This post ESG disclosures for mutual funds are helpful, but a few wrinkles need to be ironed out was original published at “https://www.financialexpress.com/money/mutual-funds/esg-disclosures-for-mutual-fund-schemes-are-useful-but-a-few-wrinkles-need-to-be-ironed-out/2465137/”

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