Unpicking the CFA’s ‘ESG Disclosure Standards for Investment Products’ consultation

By Judy Kuszewski

By Judy Kuszewski, Sancroft CEO with Ivaylo Dimov, former Senior Consultant and Michael Bateson former Senior Analyst.

The rise of sustainable investing has been impossible to ignore, as investors increasingly look to sustainability or ESG performance to achieve better returns. The UN-backed Principles for Responsible Investment (PRI) initiative recorded its 500th asset owner signatory in January this year – taking the total AUM of its membership to ~US$90 trillion – and have stated that 70% of their signatories actively include ESG criteria in their RfPs[1]. Investors are right to be this way inclined: studies, including analysis from S&P Global Market Intelligence[2], have shown that investments with strong ESG credentials have outperformed others during the pandemic.

With all that rapid expansion there is inevitably a need to take stock and assess what all this ESG investment activity means – and how it can be better understood by investors. Enter the CFA Institute, the investment management industry association, with proposed new disclosure standards[3] for investment products with ESG credentials, which aims to improve clarity and understanding of what different sustainable investment products seek to do and how they work.

There is a public consultation[4] open until 19 October. We took a look at the proposals, and share some key takeaways and feedback below.

This is not a new GRI or SASB

While investors and reporting organisations alike express ongoing concern over the seeming proliferation of sustainability reporting standards and frameworks – from the Global Reporting Initiative (GRI) to the Sustainability Accounting Standards Board (SASB), to more specialist industry-specific guidelines, carbon-disclosure standards, integrated reporting frameworks and others – the CFA’s initiative is entirely different. It is better thought of as an investment product ingredient statement , not an alternative or supplement to an annual reporting program or a certification scheme.

The CFA’s proposed standards relate to investment products, not firms. They cover the ESG approach and features of a given investment product; they do not define what ‘best practice’ is, nor the specific criteria around which to build ESG investment products. They do not address the performance (financial or ESG-related) of any given product or firm, but instead aim to help investors answer the question: Does this investment product support my ESG philosophy, and in what practical ways does it do this?

ESG activities and features linked to specific investor needs

The proposed voluntary, global standard will address definitions of ESG-related features and specific disclosure requirements related to these, covering:

  • ESG Integration – the consideration of material factors relevant to the performance of an investment that complement traditional financial factors.
  • ESG-Related Exclusions – the exclusion of securities, issuers or companies from investment universes based on ESG performance, or business segments / practices.
  • Best-in-Class – investment in issuers that perform better than peers on one or more ESG-related performance metrics.
  • ESG-Related Thematic Focus – investment in sectors, industries or companies that are expected to benefit from long-term macro or structural ESG trends.
  • Impact Objective – the positive, measurable social or environmental impact that is sought alongside a financial return.
  • Proxy Voting, Engagement, and Stewardship – the use of rights and position of ownership to influence issuers’ or companies’ activities or behaviours.

Because investors have various needs related to the outcomes they seek to achieve beyond financial returns, the proposed disclosure standards will also aim to help improve transparency about these outcomes, linked to the features above, including:

  • Improved material issues understanding and consideration
  • Alignment with personal values or moral beliefs
  • Minimising negative impacts and maximising positive impacts
  • Uncovering ESG-related investment opportunity
  • Solution-based investments that address specific environmental or social challenges or needs

It is worth noting that this breadth of potential investment needs is one of the factors behind the so-called ‘alphabet soup’ phenomenon, whereby different reporting frameworks collide with proprietary rating agencies’ questionnaires and bespoke investor research, resulting in overlapping, inconsistent, repetitive and often excessive disclosure expectations placed on reporting organisations. Investors, and indeed any users of sustainability information, don’t all want the same things – so they don’t ask the same questions. This new set of proposed standards will do little to solve this particular problem, but they should help an investor in some sense to identify the right ESG product for them – say, an impact investment that uses proxy voting and direct management engagement; or a thematic fund that invests in renewable energy in developing countries. This is potentially good for customers, by helping to simplify their analysis of what a given product sets out to do, and how.

Our views

We see this proposed standard as a necessary step to aid transparency, comparability and terminology alignment, and to reduce ESG-washing. The CFA Institute has been clear in what it does and doesn’t aim to do, and therefore the benefits and limitations. The fact that this standard is intended to build on other common frameworks will help ensure it is readily adopted.

A few specific recommendations:

  • More clarity on materiality would be welcome – and whether products should be required to provide specific disclosure on their materiality methodology and outcomes so that investors could judge for themselves whether they trust the product or feel it aligns with their needs and sophistication. This could be especially important for large asset owners (such as institutional investors and pension trustees) in selecting their investment managers – we think this could be a great aid to navigating the sea of claims and lack of consistency in language and terminology.
  • Some minimum thresholds are probably needed to safeguard the credibility of the standard, lest it create incentives for box-ticking or overclaiming. Even within the field of ESG integration, there are many degrees of depth and breadth that individual products may seek to achieve, and greater transparency on this is required. If, for example, a given product addresses one or two (or more) individual ESG elements – say, governance factors such as executive compensation or internal audit – would the product reflect ‘ESG integration’?
  • We would recommend consideration of how each of the ESG features could link to or reference frameworks relevant to or incorporated in the process – for example, the Impact feature might reference the UN Sustainable Development Goals (SDGs); or the ESG Integration feature could incorporate the TCFD recommendations or the UN Guiding Principles on Business and Human Rights. This would help ground the standard in the wider universe of ESG issues and practices.

The CFA Institute is developing its ongoing strategy in relation to ESG investment, most recently making key recommendations for integrating climate analysis into investment decisions[5]. We will be monitoring and contributing to such activities as part of our leadership in ESG integration.

We look forward to supporting our ESG clients to use tools such as the CFA standard, to help them develop their products and communicate better to markets and customers. If you would like to discuss this further, please email judy.kuszewski@sancroft.com.

[1] PRI welcomes 500th asset owner signatory: https://www.unpri.org/pri-blogs/pri-welcomes-500th-asset-owner-signatory/5367.article

[2] ESG funds outperforming in pandemic: https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/esg-funds-outperforming-in-pandemic-employees-return-to-new-normal-in-offices-58808348

[3] CFA Institute ESG Disclosure Standards: https://www.cfainstitute.org/en/about/press-releases/2020/cfa-institute-publishes-consultation-paper

[4] CFA ESG Disclosure Standards Consultation Paper: https://www.cfainstitute.org/-/media/documents/code/esg-standards/consultation-paper-on-esg-disclosure-standards.ashx

[5] CFA – Integrating Climate Analysis into Investment Decisions: https://www.cfainstitute.org/en/about/press-releases/2020/cfa-institute-makes-key-recommendations-for-integrating-climate-analysis-into-investment-decisions