Don’t try and defy gravity

Newton's first law says that an object in motion will remain in motion in the same direction unless acted upon by an outside force; an object at rest will remain at rest unless acted upon by an outside force.

An apple on a tree

"Another recent research piece – 'Power of Advice' – revealed younger family members (42%), societal pressures (47%), and media commentary (53%) were the top influences on clients considering sustainable investing."

Why have I quoted this? Well for some bizarre reason I felt compelled to think about Environmental, Social and Governance (ESG) in this context… because I believe the power of ESG considerations in investing is very much driven by investors feeling compelled to change the state of the planet, and not only is it already in motion, its momentum is increasing exponentially.

Back to earth It seems to me that you can't read the trade press without hearing about another fund launch with ESG friendly features. That's not unreasonable when you consider the level of customer interest in the whole subject, – with the pandemic seemingly accentuating this even further. However, what is less commonplace is some practical assistance on what advisers could and should do about embedding this in their suitability processes. In short there is plenty written about the 'how' but much less about the 'why'.

In terms of regulation the new disclosure requirements for advisers with respect to their environmental, social and corporate governance (ESG) policies applied in the European Union from 10 March 2021 under the Sustainable Finance Disclosure Regime. These have not yet been embedded for UK advisers, though the UK government has committed to being at the forefront of suitability and will implement its own ESG disclosure regime, so it is likely that we will mirror most if not all these requirements in the near future.

In addition, if there was any lingering doubt about the FCA's commitment in this area they have recently spoken about this in the consultation paper CP21/18. Here the FCA emphasised the importance of high-quality information on how climate-related risks and opportunities are being managed, and how this will help clients and consumers make better informed decisions about their investments.

If the UK does indeed follow the EU path, these rules are very comprehensive, but in short, the following is likely to apply:

  • Obtaining and defining the preferences of clients in respect of ESG, as part of the suitability process.
  • Mapping these to funds.
  • Providing ongoing maintenance to ensure the fund choice remains suitable.

With delegates from across the world making their way home from Glasgow, many will now reflect on what was or was not achieved at COP26. In my opinion, one of the big take aways from Glasgow is awareness.

If your clients' are more conscious about how they live their lives, it might not take too long for them to turn to their finances.

But should advisers start asking advisers questions now about ESG to ascertain their clients' thoughts? Well, yes, but caution is needed. For example, ESG is an all-encompassing term and could relate to any or all of the following:

  • Ethical.
  • Sustainable.
  • Impact.
  • Socially Responsible.
  • Climate.
  • Etc.

An ill thought through set of questions or superficial process could easily lead to problems. For example, a client could be prompted to answer "I'm interested in investing in all of them, and totally avoiding all the bad companies"! This might potentially leave an inappropriately small universe of funds for the client to invest in. Whilst that may still be achievable the adviser could easily be boxing themselves into a corner for new or existing clients without really getting under the skin of a client's real objectives.

To put it another way, you might end up with the 'ESG tail wagging the investment objectives dog'. Take the potential situation where the client is a low-risk investor but ends up with a high risk portfolio to satisfy a sustainability preference. The adviser runs the risk of not meeting the clients' overall objective, and potentially opening themselves up to a complaint.

The key bit for me is the advice firm needs to have a really robust process in place. In practice I think they need to consider two key points:

  • What overhaul of their know your customer process is needed, to drill down to a suitable level to really determine a clients ESG requirements & preferences.
  • What change is required to their overarching suitability process/centralised investment proposition/centralised retirement proposition to effectively deal with the client's wishes.

Do advisers need another reason to start thinking about this seriously now? I suggest yes for those looking to protect their client bank and the funds they have under management. Recent research from Kings Court Trust' revealed that £5.5trn is expected to cascade down the generations over the forthcoming years. Often advisers tell me that many of their clients are in their 60s or 70s, meaning that intergenerational planning is looming large in their thoughts and actions. Another recent research piece – 'Power of Advice' – revealed younger family members (42%), societal pressures (47%), and media commentary (53%) were the top influences on clients considering sustainable investing. It seems that for some bringing in the younger generation could be an ideal way for advisers to start raising the subject of ESG with their clients, which would allow them to then start raising other issues such as IHT etc.

Also, the potential consequences of not raising the subject with clients also needs to be considered. Whether advised or non-advised, the marketing activity of financial distributors is already in full swing, and likely to ramp up even further over the next few years, in line with awareness levels generally. Advisers could be leaving themselves open to challenges from existing clients if they don't start to discuss these issues soon. No one wants the phone call from a client that says, "why didn't you tell me that my pension was invested in XYZ, when there was an alternative fund I could have used to help the planet as well"!!

One of the most popular items that we have made available to advisers is the ESG client questionnaire now available on Pruadviser, – this could give you a starting point to consider your client's requirements as part of your overall process.

So, in summary I think advisers not embedding ESG in their businesses will be like trying to defy gravity. And let's be fair, Sir Isaac knew how difficult that was!

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