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ESG investing – a new requirement from 2020?

By Robert Howard, Senior Compliance Manager, Charles Stanley Wealth Managers

Charles Stanley


Clients are increasingly seeking out investments deemed ‘ethical’. Here’s how Charles Stanley plans to meet these investment goals.

Earlier this year, a Quality Circle was formed at Charles Stanley to consider the company’s position on both ethical and ESG investing (ESG stands for Environmental, Social and Governance). The Quality Circle started by noting that ‘ethical’ and ‘ESG’ are very distinct subjects.

Traditionally, investment firms have offered varying versions of ‘ethical’, in the form of positive screening (‘must do XYZ’) or negative screening (‘must not do XYZ’, for example no tobacco). However, recent years have seen the rise of ESG as an investment discipline, this being defined less by what a company manufactures or provides (the ‘what’), instead focusing more on whether it operates in a sustainable and ethical manner (the ‘how’), the theory being that in the long-term this should reduce the investment risk and lead to improved performance. It necessarily requires a deeper dive into issuers’ underlying business models, policies and practices.

There are no current regulatory requirements around ethical/ESG. However, the EU has recently agreed new ESG requirements that will slot into the Suitability requirements of MiFID. Having attended a number of industry roundtables with the FCA, it looks pretty clear that the UK is getting the new ESG requirements, regardless of Brexit. The rules, which we believe are two years away from impacting, would require Charles Stanley to collect ESG related KYC from all Discretionary, Advisory Managed and Advisory Dealing clients, and then – having first addressed their standard Suitability requirements - attempt to align client portfolios to these stated preferences. We responded to the EU consultation last year and received confirmation back that a client’s ESG preferences should not trump normal investment processes – matching a portfolio to the client’s risk profile and investment objectives - which continue to take priority. We will also ensure our client terms clarify that client ESG preferences are aspirational and we will attempt to meet them on a ‘reasonable endeavours’ basis. Achieving them cannot be guaranteed.

The implication of all of this is that Charles Stanley will require the tools and processes to allow investment managers to profile relevant clients – and their investments and portfolios – for ESG, much as we do currently for risk (using KYC and BITA). There are a number of ESG rating providers, such as Morningstar and Refinitiv (Thomson Reuters) that we are meeting with to better understand their offerings and how they could be integrated into front-office processes.

A few points of interest have emerged so far from these discussions:

First, when we tested a Motorway portfolio (the centralised research guidance that Charles Stanley provides for its investment managers), which is against the ESG ratings provided by Refinitiv, it produced a score of B-, which is perhaps not a bad score when we’re not even trying. We hope that a lesson is that clients with a high ESG expectation do not necessarily need to be invested in anything different, such as a ‘green’ fund; their existing portfolios may already be fine, or else fine with relatively minor adjustments.

Secondly, PLC coverage by ratings providers is imperfect. Big caps and some mid-caps are covered, but many small caps and AIM stocks do not have coverage yet. Speaking to the ratings providers, they are looking to expand their coverage during 2019-20 but, if not, companies will need policies around the data gaps – using sector proxies, perhaps.

Thirdly, rating providers appear to operate ‘best in class’ methodologies. Rather than ranking all stocks on one spectrum, they rank each stock against its sector – for example, they rank mining companies against other mining companies.  An A- mining issuer is not necessarily ‘better’ than a B+ telecom issuer.

Fourth, the different ratings providers all have their own proprietary methodologies, such that the same issuer can score highly with one provider, but not so well with another. It is still a subjective topic, and this may lead to interesting discussions with clients.

Fifth, it is entirely possible that tobacco, alcohol and arms manufacturers can score highly on ESG, given that ratings focus more on how and less on what they manufacture. We will need to continue to offer ‘negative screening’ processes for clients requiring such restrictions. ESG doesn’t replace negative screening, it complements it.

Sixth, there is a lot going on elsewhere in this space. The Investment Association has recently closed a consultation on the labelling of ‘green’ funds, due to concerns around what they call ‘greenwash’ – the incorrect labelling of funds as ‘green’ for marketing purposes. This should result in clearer labelling of funds.

Finally, with so much happening on ESG we are keen to ensure that whatever rules we get in the UK are not gold-plated in practice by regulators or consultants. We are chairing trade association TISA’s working group on ESG, which is working towards producing industry guidance on ‘good practice’ for firms, with the aim of ensuring a common sense, proportionate, ‘client outcomes’ approach to the subject in our sector.


Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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