ESG Through the Governance Lens

In a framework which integrates environmental, social and governance factors into decision making, ESG considers such dynamics as a company's impact on climate stability, its use of natural resources, treatment of human capital, as well as interactions with supply chains and the wider community.  As a point of convergence, governance connects and facilitates the environmental and social aspects of ESG, through the implementation of appropriate policies and procedures, oversight functions, best practices and internal controls.

Key stakeholders such as investors, investment managers and regulatory authorities have shown increasing awareness of the detrimental effect on long-term shareholder value of excluding ESG from their analysis, as social and environmental issues have come to greater prominence at this time.

As the financial services industry has engaged with ESG initiatives on multiple fronts, including corporate conduct, investment decisions, ownership activities and through regulation, it is imperative that fiduciaries now consider the ESG objectives of stakeholders through the lens of governance. 

Stakeholder Responsibility

By consciously considering societal factors and the environmental impact of their actions, investors are naturally drawn to companies and opportunities aligned with their personal values.  Coupled with the initiatives and commitments we have seen from government bodies, the focus on ethically and socially responsible investing has intensified, with investors actively engaged, including at the seed stage, further encouraging the proliferation of ESG products. 

For investment managers there are clear benefits of having a bespoke process applied to their own investment strategy and decision making, utilising different asset classes to fulfil their ESG objectives.  The equities space has the longest association with ESG, both excluding companies or practices deemed negative for society (e.g. weapons and fossil fuels) and through active engagement.  Impact investing is also being supported by managers through private debt financing including ESG-linked loans, as well as through green, sovereign and social bonds.

In the corporate loan markets, we are also seeing ESG-related margin ratchets, which debt investors are looking at in their investment decisions.  In the private equity market, ESG integration has been increasingly targeted towards carbon emissions by managers across portfolios.

Some financial institutions have embraced responsible investing through the establishment of the Six Principles of Responsible Investing ("UNPRI") created by the United Nations in 2006.  The UNPRI has been a key development, as a mechanism for managers to implement ESG into investment decisions and as investors drive greater adoption of ESG policies and criteria by managers, it has necessarily become an important focus for regulators and legislators.

Emerging Regulation

The European Commission has enacted multiple reporting requirements for asset managers and financial market participants, with the Low Carbon Benchmarks Regulation and the Taxonomy Regulation, introduced alongside the Corporate Sustainability Reporting Directive and the Sustainable Finance Disclosure Regulation ("SFDR").  The SFDR requires pre-contractual, periodic reporting and website disclosures for sustainability-focused funds, and Ireland and Luxembourg are popular EU jurisdictions for establishing such funds under this regime.

Although the UK did not adopt SFDR with its departure from the European Union, climate-related reporting requirements will be required by asset managers and asset owners under the Task Force on Climate-Related Financial Disclosures ("TCFD"), which forms part of the UK's Roadmap to Sustainable Investing.  Irrespective of the stage of UK legislation, many UK investors are looking at this through a global best-practice perspective and are very focused on both the environmental and social impact of their investments – we are regularly seeing this in the investment decisions of UK pension funds and other major investors.

In other jurisdictions such as the United States, the inclusion of ESG considerations has been largely driven by the marketplace and not mandated by the US Securities and Exchange Commission ("SEC").  However, in 2022, the SEC published proposed rules in relation to the disclosure of ESG factors for registered companies, investor advisers, business development companies and certain unregistered advisers.  Where a fund is ESG-focused, the disclosure of carbon footprint and carbon intensity is also proposed.  An amendment to the current naming rule, Rule 35d-1, has also been put forward to include ESG considerations. 

Under Canadian securities laws, there are certain proposed disclosure requirements such as through the National Instrument NI 51-107, where all reporting issuers would be required to disclose their governance practices around climate-related risks and opportunities.  NI 51-107 largely aligns with the framework of governance, strategies, risk management, metrics and targets, recommended by the globally supported TCFD.

In Singapore, both the Monetary Authority of Singapore ("MAS") and the Singapore Exchange ("SGX") have set out ESG parameters.  MAS has set environmental risk management requirements for the energy, transportation and real estate sectors with touchpoints to issuers, fund management companies and real estate investment trust managers.  SGX has also established a common set of core ESG metrics, highlighting key areas such as greenhouse gas emissions, water and energy consumption, and waste generation.

Elsewhere in Asia, ESG disclosures have also been introduced by the Financial Services Agency of Japan ("FSA") comprising of the TCFD's four core disclosure elements.  ESG funds must also disclose ESG factors and associated risks and limitations within their investment strategies.  The FSA have also stated that where a fund does not meet relevant ESG standards, it cannot use ESG or suggestive ESG terms in its name in an effort to prevent greenwashing.

With respect to the Cayman Islands, the Cayman Islands Monetary Authority published an information circular in 2022 highlighting its participation in international engagements, reviews and assessments, with the intention of developing a suitable regulatory and supervisory approach for climate and ESG risks.

As regulators continue to focus on asset allocation, reporting and disclosures in the context of ESG, certain issues have tended to come to light across jurisdictions, notably obtaining reliable information as it relates to how ESG is being integrated into a strategy, green washing and the subjective elements of ESG scoring.  While regulators seek to address these complexities, the depth of direct regulator involvement has also created some concerns, further underscoring how governance operates as the control room for their mitigation.

Corporate Governance in the ESG Landscape

In pursuit of good corporate governance, fiduciaries should always consider the holistic impact of ESG on its fund, taking all key stakeholder expectations into account.

A fund may have all, or only certain ESG components built within its investment strategy and objectives, and investors rely on the fiduciaries and more broadly the governance framework to ensure that the fund conforms.  From an investment standpoint, fiduciaries should consider how these ESG factors are being implemented and periodically reviewed, such as the arrangements in place for monitoring and reporting the environmental impact associated with the fund's target investments.

Where there is a social emphasis to a fund's investment decisions, the fiduciaries should consider issues regarding labour practices and the workplace environment of target companies, while critical governance components such as the legal, compliance and risk functions reflect the overall control environment.  Where applicable, discussions regarding any ESG scoring or rating undertaken for investee companies should also be part of the conversation.

ESG scoring is largely driven by rating agencies who assess companies' data using their own proprietary methods which may cause complexities due to a lack of score standardisation.  An ESG scorecard is used to ascertain an overall evaluation of an investee company's performance against various key metrics such as the Global Reporting Initiative, the Principles for Responsible Investment and the Sustainability Accounting Standards Board.  Fiduciaries can be more effective in an oversight role where they can establish a baseline understanding of how an ESG scorecard is derived and where the underlying scorecard data is being obtained.

Investment managers may additionally have their own responsible investing principles and ESG policies and procedures in place that impact the way in which a fund is managed.  This should also be considered by the fiduciaries to ensure there is no misalignment between management and the fund's investment objectives.

The fund will also have separate ESG reporting and disclosure requirements dependent upon the jurisdictions the fund operates and where it is marketed.  It is therefore incumbent upon the fiduciaries from a governance perspective to ensure regulatory compliance within these respective jurisdictions.  This may include ESG disclosures within the financial statements, metrics reporting, offering document and marketing materials, as well as ESG investment concentration requirements; and the alignment of the fund name with the investment strategy.  As the global ESG regulatory landscape continues to develop, the role of the fiduciary evolves and directors will need to ensure their knowledge of all requirements which may ultimately impact the fund, remains current.

Overall, a full understanding of the requirements of key stakeholders within the ESG space is essential for good governance and making sure the fund remains in good standing with all its obligations.  As the concept of ESG can be interpreted fairly broadly, an absence of good governance can potentially undermine efforts towards meeting the fund's ESG targets, so it is imperative fiduciaries ensure that an appropriate governance framework is established when implementing and monitoring the ESG objectives of their respective fund.

The Maples Group

The Maples Group's global ESG Advisory Group is a dedicated, multi-disciplinary team of ESG and sustainable finance experts from across our various specialist practice areas, including Banking, Finance, Corporate, Funds and Investment Management, Tax and Regulatory and Financial Services Advisory.  Our multi-jurisdictional capabilities ensure that we have exposure to global ESG trends and sustainable finance developments.  This allows us to draw on the experiences and expertise of the entire Maples Group, to develop a uniform and consistent approach to ESG initiatives for our clients around the world and to meet the needs of key stakeholders in the evolving ESG landscape.

Our ESG Advisory Group collaborates with leading international clients and institutional investors to achieve their ESG objectives at both an investment and operational level.  We also continue to engage with governments, regulators and industry associations in many of the jurisdictions in which we operate, to help shape the financial services industry's response to developments in ESG and sustainable finance regulation.

The Maples ESG Platform ICAV (the "Platform") was established to host and further support Article 8 funds (which promote ESG factors) and Article 9 funds (which target sustainable investments) under the SFDR, for distribution in the European Union.  The Platform is an Irish Collective Asset Management Vehicle which is an umbrella fund specifically structured to host environmental, social, governance and sustainability-focused funds, managed and promoted by MPMF Fund Management (Ireland) Limited, the Maples Group's alternative investment fund manager and UCITS management company.

It provides a turnkey solution for clients looking to launch a segregated EU SFDR-compliant Article 8 or Article 9 sub-fund and take advantage of the high demand for ESG-focused funds in Europe.  EU and non-EU clients looking for a flexible solution for SFDR compliance and European distribution can take advantage of an established fund platform with regulatory approval and legal agreements already in place.  The platform affords clients access to industry leading ESG practices and service providers for ESG advisory, fund management, fund distribution, operational and reporting solutions, including exclusive access to a first-of-its-kind solution for independent certification of a fund's and manager's ESG strategies.