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We are at the turning point for retail investment in ESG

01/03/2019

The argument that returns from ESG-linked investments are worth more than a second look is playing out to the extent that buying into the sustainable finance model is nudging its way towards the mainstream.

Taking account of environmental and social governance (ESG) factors in investment decisions is just good management, according to Isabelle Millat, head of sustainable investment solutions for global markets at Societe Generale. The question then becomes, if this approach has become entirely acceptable and, in fact, a fiduciary duty for pension funds, why wouldn’t retail investors benefit?

The reticence retail investors have had about investing in ESG-linked financial products has been attributed mainly to their naked desire for returns, or lack of knowledge of available solutions. While institutional investors have, for a couple decades, exercised their liberty to invest sustainably, the smallest pockets in the investor universe have struggled to contemplate investing with their conscience.

But now that’s changing, catalysed by the communication on ESG solutions, and the headline benefits of going down the sustainable route. Over the last five years, a live Societe Generale strategy comprising a quantitative selection of best-in-class ESG stocks has outperformed European benchmark the Stoxx 600 by 27.7%. “We are now able to first select an ESG-compatible investment and have enough experience with structured solutions to deliver the same level of coupon or capital protection,” said Ms Millat. “Our retail share is above 50%, because we create so many of these solutions.

Exclusion is one approach, but more and more investors want to seize growth opportunities and positively select the best ESG leaders across industries,” said Ms Millat. “If you set a standard, rather than a proscriptive result, you support the growth of a robust, transparent market.

“We have an index where we first select companies that contribute to the achievement of the United Nations’ sustainable development goals and exclude companies whose activities could create an obstruction to the achievement of those goals,” said Ms Millat. “The performance is enhanced by risk control filters that have been applied to make the index call-friendly.”

We are at the turning point. Historically, the talk was more of an institutional investor market, but now asset managers have paved the way for the integration of ESG factors when selecting stocks or bonds in their products, in line with the UN Principles for Responsible Investment. To date, over 1,500 asset managers have committed to incorporating this guidance, with comparable sets of rules for insurers, and Principles for Responsible Banking launched at the Paris Climate Finance Day on 26 November 2018.

Other than anecdotal evidence gleaned from individual transactions, the latest European Sustainable Investment Forum (Eurosif) report provides further support for the evolution: the retail share of ESG investment was over 30% in 2018, rising from 22% in 2016 and far above the 3.4% recorded in 2014, according to Eurosif.

The desire is further enhanced by the development of regulation that has been specifically designed to support sustainable finance. “The regulation is rapidly turning into reality, with the bulk of the rules due to be implemented in 2019,” said Ms Millat.

The European Union Technical Expert Group on sustainable finance published a first draft of a classification system within its Sustainable Action Finance Action Plan in December 2018 with the ensuing consultation to be followed by an agreement on the taxonomy by May 2019. More generally, the European Commission is rolling out a comprehensive action plan to support sustainable finance, which includes the definition of ‘low carbon’ benchmarks, and the integration of sustainability risks and factors in Mifid 2.

In France, there was a watershed moment in July 2018, where it was decided that, under certain guidelines, ESG was no longer considered a complexity factor for ESG index-linked products sold to retail investors, which has created a huge momentum in the market. The new guideline was created only after a lengthy collaboration with trade and asset management associations, which resulted in a definition of the filters and data for these indices. “We now have a guideline of how to build a transparent and robust ESG index for retail, rather than a proscriptive template of what the result should be,” said Ms Millat. “If we define a very narrow, strict solution for ESG, we are just going to miss the point that ESG research is getting better, and we want to seize on that continuous improvement.”

Furthermore, the Belgian regulator is creating rules for sustainable investments, anticipating the work being done at a European level.  “They know that if they are advanced, their standard will be taken as a reference and spread through Europe,” said Ms Millat. In the UK, it has already been decided that pension funds have a fiduciary duty to include material ESG factors, an approach that has been broadly adopted in other countries.

There is a need for more investment options, although the supply is increasing, according to Ms Millat. When it comes to product, institutional investors tend to buy stocks and bonds, especially green bonds or those from companies with good ESG credentials, on the back of research, while retail investors are now moving towards more customised and packaged investments.

“Societe Generale is well-positioned for this move, through its state-of-the-art ESG research, a leading index business and its financial engineers,” said Ms Millat. “With retail, it is important to look at what they invest in and create an ESG version of that, rather than asking them to buy a one-size-fits-all,” said Ms Millat.

“We also produce Positive Impact Notes, which include a sustainable component: Societe Generale makes an additional commitment that it will hold, on its balance sheet, an equivalent amount in Positive Impact Financings for the term of the note,” said Ms Millat.

Examples of Positive Impact Financings include a framework of Positive Impact Loans created by the bank for small- and medium-sized enterprises (SMEs) in areas of France where unemployment was higher than the national average: investors in these notes will support around 3,000 SMEs, representing around 100,000 jobs. “The solution, from a financial standpoint, is fully customisable, but the funding element of the solution reflects our commitment to Positive Impact Finance,” said Ms Millat.

“It is a commitment of our balance sheet and our resources” and includes an annual external audit and a report to investors, according to Ms Millat.