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04 November 2021

Understanding CFA Institute’s New ESG Disclosure Standard for Investment Products

With all of the insights on ESG topics in the investment industry today, there are still many questions unaddressed. For example, how does a particular investment qualify as ESG? Why are ESG scores and ratings all over the map? What is the correlation with ESG to investment performance? And put simply, what is the best way to explain ESG to clients?

With demand growing among investors for ESG exposure, and advisors facing the need to respond, CFA Institute is undertaking a significant effort to bring structure to the evaluation and presentation of ESG-related opportunities. This month, CFA Institute is expected to introduce the ESG Disclosure Standards for Investment Products (the “Standards” or “ESG Disclosure Standards”), the culmination of two years of study, draft concepts, and industry feedback. CFA Institute has a long history of helping elevate professional standards and transparency in the investment industry, most notably with the Global Investment Performance Standards (GIPS®).

Crista DesRochers, a partner with ACA Group and member of the ESG Disclosure Standards Verification Subcommittee, provided an early draft preview at SS&C Advent’s Engage conference in September. The need for an ESG disclosure standard was identified in a 2019 initial consultation paper on ESG disclosure standards circulated by CFA Institute’s ESG Working Group to the investment community where more than 70 percent of respondents agreed there is a need for a standard. New ESG disclosure standards will bring transparency to ESG-related features of investment products and will also help investors compare products across managers.

The new ESG Disclosure Standards provide a global, voluntary framework for disclosing ESG-related features of investment products, which include any vehicle – including pooled funds and separate account strategies. The Standards do not prescribe what constitutes an ESG investment. Instead, it calls for investment advisors to explain to clients the process by which they ascribe ESG-related features to a particular investment. Advisors must also disclose the ESG-related features of the investment product before the client decides to invest in the product. For an independent advisor constructing a portfolio for a client, selecting specific securities, or even using a model, the disclosure helps explain how the advisor is applying ESG criteria.

The Standards are not meant to be applied firm-wide but only to specific investment products a firm presents or recommends to clients. Additionally, the product doesn’t have to be green per se – for example, a renewable energy fund – but rather any investment product that uses ESG information or addresses ESG issues. That can include, for instance, a traditional large-cap strategy that integrates favorable ESG ratings based on their environmental or employment practices into their investment process.

The ESG Disclosure Standards set forth specific requirements for firms wishing to comply, including the need to:

  • Document policies and procedures used to maintain compliance
  • Capture and maintain records associated with compliance
  • Avoid presenting false or misleading information
  • Provide a “compliant presentation” to clients before they invest in the product

A compliant presentation discloses what and how ESG information is used in the investment process, stewardship activities related to ESG issues, and impact objectives as defined in the Standards, among other considerations. The presentation must also disclose for which period the investment product claims compliance and any material changes made that effect information included in the compliant presentation.

As with the GIPS standards, compliance with the new ESG Disclosure Standards is strictly voluntary – which raises the question, why should firms adopt them? There are several reasons for firms to consider complying. First and foremost, advisors are under increasing regulatory pressure to demonstrate they “say what they do and do what they say.” With no common definitions of ESG and lack of ESG-specific regulation in many markets, including the U.S., advisors risk greenwashing claims and misleading investors when marketing ESG. Following the Standard helps mitigate that risk while bringing efficiency and consistency to a firm’s ESG policies. Many firms have already developed policies and criteria for integrating ESG factors into their investment processes, and the Standards serve to codify the work they have already done. Besides, compliance with the Standards is relatively simple and low-maintenance. If it helps boost client trust and confidence in a firm and its advisors, the question changes from why, to why not?

The U.S. investment industry is anticipating ESG regulation, though what shape it will take is still uncertain. In the EU, for example, the Sustainable Financial Disclosure Regulation (SFDR) will take effect in 2022, requiring firms to report their ESG efforts. Currently, we do not expect U.S. regulation to be as prescriptive as Europe’s. Instead, it may take a form similar to the CFA Institute’s ESG Disclosure Standards, focusing on how firms approach ESG rather than trying to define it, or perhaps find a comfortable medium. Regardless of the direction the SEC takes, the ESG Disclosure Standards could represent a way for the industry to get in front of regulation if enough firms sign-on.

The ESG Disclosure Standards are bound to evolve as firms start putting them into effect. For now, however, simply having a framework in place is expected to bring the necessary consistency to the subject and help advisors have increasingly productive client conversations on unlocking the ESG potential. For a deeper dive, watch the entire presentation from SS&C Advent Engage.

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