Have you thought about the “Cs” in ESG? has been saved
Have you thought about the “Cs” in ESG?
Why credibility and confidence matter in a sustainable business model
Performance Magazine - Issue 37 ⬤ Published on 18 November 2021
Have you thought about the “Cs” in ESG?
Why Credibility and Comfort matter in a sustainable business model
To the point
No surprise: environmental, social and governance (ESG) is one of the hottest trends for actors in the financial product market. The figures speak for themselves – outstanding growth rates in funds’ assets under management (AuM) on a quarterly basis as well as total AuM close to USD 4 trillion globally. This sky-rocketing demand, especially in Europe accounting for 88% of the Global AuM, has created a crowded marketplace, with fierce competition to attract the attention of investors and distribution partners.
So far, so good, you could say. However, since the growth of available capital for investments is not keeping up with the growth in products offered, market positioning, branding and marketing are increasingly helping market players set themselves apart. For firms to win this race, they must stand out from the crowd, especially when regulatory guidance and clarity are still in their infancy.
This is where Credibility and Comfort start to matter. Not only for manufacturers of financial products, but for all stakeholders across the entire value chain to the (end) investor. It is about firms being willing and able to constantly test their ESG value proposition claims. And, it is about providing proof points that underpin these claims to earn long-term Credibility and provide Comfort to all stakeholders accordingly.
Synonyms for Credibility, which derives from the Latin word credibilis, are trustworthy and trust. Similar to Credibility and Comfort, trust must be constantly earned and maintained over time to be sustainable in the long term. So, this is not a one-off exercise—it is permanent and requires constant attunement and investment across the value chain to materialize.
 Source: Morningstar, Global Sustainable Fund Flows Q3 2021, November 2021 – updated version
A lot is being said about the challenges asset managers and other financial product manufacturers face regarding ESG—including integrating ESG aspects into their investment processes, the ESG data challenge, the need for internal upskilling, and the growing compliance burden with every new or changing regulation.
But often, this ESG effort is an inward-looking approach, covering only the first part of the above equation. Manufacturers are not always in a position to consider the value chain all the way to distribution. This can be due to regulatory uncertainty, a lack of internal ESG competence, or a shortage of specialized talent. However, make sure the distribution side and investors are not left out of sight!
But who are the stakeholders, and what is the value chain?
Figure: stakeholders in the asset management value chain (simplified)
Why does Comfort matter?
Supervisory boards, senior executives and other top-level management are naturally motivated to grow their business, in compliance with applicable rules and to benefit investors. They are especially motivated to ensure sound internal governance, often looking to internal control functions to provide Comfort that this governance is being maintained in a changing and growing business.
To grow mainstream, integrated, living and breathing ESG, there must be non-financial benefits for investors. However, the development and implementation of regulatory guidance have been, to be generous to the lawmakers and regulators, somewhat sub-optimal.
This situation is arguably improving with the European Supervisory Authorities (ESAs) having delivered the final regulatory technical standards (RTS) for the Taxonomy and Sustainable Finance Disclosure Regulation (SFDR). However, implementing these standards, which will include new product “classes”, will take time and has been postponed further until 1st of January 2023—and must be done under the watchful eye of regulators, press, institutional clients and distribution networks, the latter of which needs the information to be delivered under the RTS already earlier than 2023, namely by August 2022!
Recent examples have publicized the effect external scrutiny can have on a firm’s brand, reputation and share price when its ESG capabilities are in doubt. Such scrutiny does (and should) cause concern among leaders, driving firms to enhance their assurance efforts to boost internal governance Comfort and satisfy external stakeholders. However, enhancing oversight and boosting Comfort levels potentially generates increased costs and distraction in the value creation process.
Consequently, Comfort in processes and procedures is crucial for firms to operate efficiently, especially in the ESG domain. It is a vital part of how reporting should be handled, especially when challenged through external scrutiny. Firms need to be able to prove that they walk the walk as well as talk the talk. Therefore, the stronger the proof points, the better the constant overview, and the higher the stakeholders’ Comfort.
However, it is not enough to only find Comfort in some teams or certain people. Each manufacturer could ask itself, can I put my organization to the test? Is our sustainability value proposition understood? Does everyone know what we stand for and how they individually, or as a team, contribute to our firm’s overall ESG strategy?
When a firm and all its internal stakeholders speak with one voice and understand as well as embrace the firm’s ESG agenda, it inspires Comfort in clients and distribution partners. The latter may quickly realize that ESG is more than just lip service from a few employees; it is truly embedded in the firm.
Lastly, generating Comfort is not just about stakeholders’ peace of mind—it can also drive efficiency. If everyone has clear access to all relevant information and an aligned understanding of its meaning across the value chain, data will become living knowledge—and, therefore, more efficiently processed.
 ESAs have delivered to the European Commission their Final Report with draft Regulatory Technical Standards (RTS) regarding disclosures under the SFDR as amended by the Regulation on the establishment of a framework to facilitate sustainable investment (Taxonomy Regulation). However, the European Commission has communicated end of November 2021 that the application will be deferred to January 2023.
 „From Dead Data to Living Knowledge”, Nicolas Buck, Deloitte Performance Magazine, 2021
Credibility to complete the virtuous circle
Credibility is the “intangible” currency that asset managers or financial product manufacturers is paid by the market.
Net flows and AuM increases, decreases and retention determine and dictate financial and tangible success, and are often supported by strong brand recognition. While this is no different in the world of sustainability, ESG is a very vivid field—it is not just a new asset class or investment approach, it must be integrated into everything we do. So, while brand recognition, net flows and AuM are relevant in the short term, what about the long term?
In the long term, clients, distribution partners, auditors and probably even regulators will test the Credibility of product manufacturers, including the way products are promoted. Promotion is an essential piece of the puzzle, since often (very) sophisticated ESG approaches must be explained in an understandable and meaningful manner. So, firms should ask themselves, do our promotional materials meet these criteria? Do they describe the core of the offer in such a way the target audience will get? In the words of Albert Einstein: “If you can’t explain it simply, you don’t understand it well enough”.
While keeping it short and simple is near impossible given the lack of aligned definitions, taxonomies and understanding, the amended Markets in Financial Instruments Directive (MiFID) has required this for many years. It is about being fair, clear and non-misleading, which are essential criteria regarding ESG. While admittedly not as relevant for certain products that are exclusively directed to well-informed institutional investors, keeping it understandable to the target investor will undoubtedly add Credibility.
As another consequence, the virtuous cycle of Credibility and Comfort is complete once more. Why a virtuous circle? Because firms cannot sustain one without the other in the longer term. When firms are credible in the “what” and “how” of their ESG strategies, it provides Comfort to all stakeholders, whether internal or external. It will facilitate communication and the provision of solutions, not just products. Distribution partners will see firms as trusted advisers and not just another manufacturer. In other words, it will help players stand out in a fiercely competitive marketplace.
Market players could be tempted to view ESG for funds or financial products in general as a straightforward equation. You look at the product and its ESG potential, and make sure you have the proof points and evidence in terms of verifiable (external) data or research. Then, you manage and market the product accordingly. But this equation does not always reflect the reality, unfortunately.
To integrate ESG considerations into financial products, the “Cs” must be a key consideration. They are less tangible than quant-driven data; they require engagement with stakeholders that surpasses the traditional agenda of understanding short-term financial and business needs, urging manufacturers and distributors to look beyond the end of their noses. After all, achieving Credibility and Comfort by truly embracing ESG across the entire value chain will definitely be rewarding.
Understanding the drivers that define a firm’s sustainable business model is not always easy, and boards and senior management will struggle to achieve this from time to time. Regardless, whether you are an asset manager, bank, insurer or another type of distributor or intermediary, do not be afraid to put yourself to the test. And, do it regularly, using complete overviews or dashboards.
This continual testing will likely reveal that, due to shifting results and parameters, you must remain agile and constantly adjust plans and strategies. While it is an intensive job, it is a must to achieve a sustainable business model that provides and secures Comfort and Credibility in your ESG approach.