Environmental, social and governance (ESG) is a relatively new paradigm in the investment service area. For a number of years, similar concepts have existed (such as responsible, green or ethical investing), but the intensity of the current interest in ESG and related issues such as sustainability, climate change and equality has escalated in importance and, for many people and institutions, become truly profound.

ESG-focused investments have grown significantly as a result, even if the sector still counts for a small part of the investment universe. In many cases, ESG is one of the fastest-growing investment themes: for example, the Swiss Sustainable Investment Market Study 2019 noted that growth tracked at more than 80% between 2017 and 2018.

While in the past, investing in high-grade ESG/sustainability products was seen to mean forgoing some degree of performance and returns, this is no longer the case. More and more messaging around ESG investing has focused on the ability to outperform – particularly over the long term – as a direct consequence of ESG filters (measured in terms of profitability on risk; see table below. Source: MSCI, J.P. Morgan Quantitative and Derivatives Strategy (Performance between September 2007 and November 2016)).

For instance, the quality of management at a business has always been one of the major criteria for professional investors in evaluating a company; hedge fund managers typically conduct interviews with the company’s senior management before deciding to invest. As ESG has become ever more important, the quality of a firm’s management has increasingly reflected its ESG strength. In addition, the rise of data providers that evaluate a company in terms of ESG are further driving the issue and, importantly, standardizing metrics.

It is clear that regulators are also increasingly taking ESG/sustainability criteria into account. The European Commission, for instance, recently published a draft of the “Delegated regulation amending Regulation (EU) 2017/565 as regards the integration of Environmental, Social and Governance (ESG) considerations and preferences into the investment advice and portfolio management”. Unsurprisingly, we expect the level of new regulation and requirements to escalate as we look ahead.

Market needs

What is envisioned by the industry and regulators is the full integration of a range of ESG/sustainability criteria into the investment proposal offering. This has different aspects, including:

a) Clients must be profiled for their ESG/sustainability preferences. The modelling of these preferences is complex due to the lack of standardization (the EU has an expert group working on a “sustainability taxonomy”) and the relatively high number of information that must be collected:

  • environmental criteria such as GMO use, CO2/GHG emissions, water consumption, pollution, waste management, air emission, use of paper and recycling;
  • social and corporate social responsibility (CSR) criteria such as non-discrimination, responsible marketing, educational, minimum wages, labour issues, ethics and child/forced labour;
  • governance criteria such as policy against bribery and corruption, insider trading, conflict of interest, competition and money laundering.

Clients may also want to avoid investing in “critical” industries like animal production, fishing, uranium, tobacco, alcohol, weapons and gambling, or they may not want to go in the above criteria in great detail and only request some general level of ESG/sustainability quality in their investment.

b) The asset proposed must have the corresponding classifications to be matched against the client investment profiles. Normally, these classifications are done at issuer level, but it may be at issue level too (take “green bonds” for example). Global market data providers are delivering this kind of data and are also calculating a synthetic “rating” of the issuer, similar to the credit ratings of S&P, Fitch and Moody’s.

Avaloq vision

Avaloq considers ESG/sustainability requirements a matter of course for banks’ and wealth managers’ investment service offering. Providing unparalleled, data-rich support for relationship managers/asset managers is a key strategic direction for us.

Our Avaloq Investment Suitability Framework is perfectly suited to cater for the rise in ESG and the need for dedicated data analytics. Embedding such processes and logic into our solution will dramatically simplify the offering process, allowing banks to deliver relevant products and to also enlarge their product suites from the traditional client segment of private banking to other segments.

We plan to use data science services to extract the highest business value from the data stored in Avaloq’s solutions, thus helping stakeholders to identify new trends and opportunities that can be quickly developed and rolled out in this new exciting investment segment.

 

 

Roadmap

We’re currently working on the integration of ESG/sustainability aspects into our wealth management front-office tool, with a view to being able to deliver a fully digitalized experience for the investment service business. Our BPaaS and SaaS delivery models mean that users will be able to immediately leverage the ESG experience of a large, global community of banks.

The solution will be rolled out in 2020, starting with the ESG/sustainability adapter for a chosen market provider followed by the implementation of Avaloq Investment Suitability Framework rules.