BlueMark and Morgan Lewis Publish Whitepaper for Sustainable Investors on Best Practices for Complying with Financial Regulations and Aligning with Industry Standards
Asset managers today must address an ever-growing list of rules and expectations from regulators, investors and other stakeholders about their approach to sustainable investing. From the passage of anti-greenwashing rules in Europe to the launch of new standards for sustainability reporting, it can be a daunting task for investment firms to keep up with the market’s rapidly evolving requirements.
WATCHa recording of a webinar introducing the report that inclues perspectives from two asset managers who have been working to adapt their policies and practices to keep apace with the market.
This piece was originally published in ImpactAlpha.
Most of us were taught growing up that the ends don’t justify the means. It matters how you go about achieving your goals. The same is true when it comes to impact investing – the process by which investors achieve their results matters as much as the results themselves. Just as an athlete or musician can only master their craft through disciplined practice, an impact investor will be better-positioned to achieve impact results if they have high-quality and rigorous impact management practices.
The good news is that the impact investing industry is advancing standards for both practices and performance, with recent progress particularly on practice standards. These standards and frameworks – notably including the Operating Principles for Impact Management (Impact Principles), Impact Management Project (IMP) and the SDG Impact Standards – describe how investors can integrate impact considerations throughout the investment process, from goal-setting to due diligence to exit.
Still, many practitioners are unsatisfied with the focus on process and practice, and believe that impact performance results and outcomes (e.g., carbon emissions reduced, quality jobs created, lives saved or improved, etc) speak for themselves. While it is hard to debate that results matter, the standards for impact performance reporting are still in development.
However, in the meantime, most investors and companies lack the information needed to effectively compare one firm’s impact performance results to another’s.
While efforts to establish unifying standards for impact performance measurement and reporting continue, rigorous evaluation of investors’ impact management practices can tell us a great deal about the authenticity of an investor’s stated impact objectives and their chances for achieving those objectives.
Consider a scenario where two fund managers specializing in real estate both claim to deliver similar levels of impact and financial performance – for example, providing 10,000 affordable housing units to communities in need while earning risk-adjusted returns of 6-8% per annum. An expert, third-party verification of those managers’ impact management practices by a firm like BlueMark would provide insight as to how each manager:
Defines and evaluates expected impact for each potential investment property;
Tracks and monitors whether the properties are achieving the impact expected; and
Works with property managers to solicit input from community members and other stakeholders in the evaluation of impact and to address instances of impact underperformance;
These are among the kinds of practices that the impact investing community considers proper impact management. Naturally, it’s fair to expect that the manager with the more thoughtful and disciplined approach to impact management would be more likely to realize optimal impact results.
This is why independent verification is an important enabler for allocators to efficiently “look under the hood” of managers’ investment practices to understand how effectively impact considerations are integrated throughout the lifecycle of the investment. A well-designed verification methodology that’s grounded in impact management expertise can be an important due diligence tool for allocators looking to compare the practices (as well as the performance) of various fund managers.
The standardization of best practices in impact management
The rapid rise of standards like the Impact Principles and SDG Impact Standards shows that impact management practices will remain an important piece of the impact investing puzzle. Already, there is a growing expectation that impact investors be aligned to one or more of these standards, with third-party verification emerging as an important accountability mechanism to assure that investors have the right systems, processes, and capabilities to contribute to achieving the intended impact.
BlueMark’s ‘Making the Mark’ research report, which was based on 30+ verifications of impact management systems, showed significant differences in how investors approach impact investing, with some investors earning top scores on their alignment with the Impact Principles while other investors had significant gaps or shortcomings in their approach. To take our research a step further we created the BlueMark Practice Benchmark, which functions both as a resource for investors to be able to see how they stack up against their peers and as a tool for asset allocators and other market participants to differentiate between Practice Leaders (those in the top quartile) and Practice Learners (those in the bottom quartile).
While impact investors shouldn’t lose sight of the importance of delivering impact performance in line with stated goals, the process by which those outcomes are achieved is just as important. Impact investors should be able to show, for example, that they are contributing to the achievement of reported impact results, engaging with investees to minimize negative consequences, risks, or side-effects, and taking measures to ensure impact is sustained beyond the life of the investment.
One day the impact investing industry may find a way to integrate both practices and results into a comprehensive disclosure and reporting framework. Until that day arrives, it’s imperative that impact investors back up their impact claims by adopting standards for impact management practices in addition to reporting out on their results.
Christina Leijonhufvud is the CEO of BlueMark, where she manages all aspects of business strategy, new product development, and external relations. To date, BlueMark has completed 40+ impact verification assignments across investor types and asset classes.
This article was originally published in FundFire and is co-authored by Tristan Hackett, Director, Europe for BlueMark, and Christina Leijonhufvud, CEO of BlueMark.
Private fund managers may know their investors are increasingly embracing sustainable, impact or environmental, social and governance investment approaches – and that regulators across the globe are boosting focus on these strategies.
But managers now face a daunting new regulatory standard – stricter definitions of what constitutes responsible investment strategies that not only exposes these firms to compliance scrutiny, but also lets investors quickly assess whether a private fund meets the mark or is merely wrapping itself in green offering documents.
The U.S. is still taking its first steps on this path, with the Securities and Exchange Commission this year issuing a new ‘Risk Alert’ on ESG investingoutlining the early stages of examining investment advisers for “greenwashing.” But the major shift has taken place in Europe, a market most private fund managers can’t ignore – and that historically has paved the way on ESG issues in the U.S.
The European Union made a gravity-shifting move earlier this year by introducing formal requirements for the Sustainable Finance Disclosure Regulation (SFDR) that represent one of the most direct anti-impact washing efforts to date.
Our recent public statement on the SEC and SFDR warns managers that the earth has moved: “Regardless of which label an investor chooses to use – ESG, responsible, sustainable, impact, etc. – the message from regulators is clear that investors must have the right policies and practices in place to back up what they claim to be doing or the results they claim to be achieving.”
But managers should also recognize that these new standards have the potential to push existing impact management concepts and best practices into the mainstream. SFDR aligns with and reinforces existing impact investing frameworks and standards, like the Impact Management Project (IMP) and the Operating Principles for Impact Management (the Impact Principles). And its activation represents an important inflection point for the financial community broadly – and for the sustainable finance community specifically – in the fight against greenwashing and impact-washing.
SFDR is at heart an anti-greenwashing rule that requires all investment firms operating in Europe to categorize their investment products according to how they approach sustainability risks and opportunities. Investment managers with responsible investing products can choose among three different categories, each with specific and increasingly stringent disclosure requirements. These categories also roughly align with the IMP’s ABC classification framework introduced in 2015, which encourages investors to think more holistically about the positive and negative impacts of their investment decisions.
The first category, Article 6, is the minimum standard, which requires all financial market participants to disclose their policy on integrating sustainability risks and, in doing so, show how they do (or do not) “avoid harm” in their investment decision-making processes.
The second bucket, Article 8, is a higher standard for investment products that are actively promoting environmental and social characteristics, and it requires investment managers to disclose how they seek to “avoid harm” as well as “benefit stakeholders.”
The last grouping, Article 9, constitutes the highest standard, and is generally applicable to funds that have sustainable investment as their core objective. Article 9 requires investment managers to go a step further and disclose how they are actively “contributing to solutions,” particularly as it relates to climate change and other sustainability issues.
The higher bar for Article 9 funds represents a significant nod to many of the existing industry best practices for impact management. But whether an investor aims for a low bar or a high bar, the entire market benefits when there is a shared understanding of who is doing what and why.
Private fund managers should be thoughtful regarding which category they choose. While many investors may opt for the slightly less onerous Article 8 designation, we believe any self-described impact investors should be prepared to be accountable for the Article 9 designation.
Picking a category is merely the first step. Private fund managers will need the right tools and frameworks to get into compliance with SFDR. A good starting point for managers still unfamiliar with IMP and the Impact Principles would be to ensure they have developed a robust thesis that articulates the fund’s concrete ESG or impact objectives (while drawing on industry standards), and that describes how the investment strategy helps to achieve those objectives.
SFDR will not only change the game for managers in their compliance function. Initial data on the European investment universe shows just how far SFDR’s reach could be across managed assets in the market. A recent Morningstar analysis of more than 150,000 investment products found that 20.9% of funds are classified as Article 8 and 2.7% are classified as Article 9, representing $2.5 trillion in combined assets under management. Several of Europe’s biggest asset managers – including Amundi, BNP Paribas and Robeco – are reportedly planning to have at least 75% of their assets aligned with either Article 8 or Article 9 by the end of the year.
The investment management industry’s current impact-washing and greenwashing problem is in large part caused by financial market participants identifying themselves as “impact” or “sustainable” without any concrete evidence to back up such claims. SFDR was specifically designed to confront this problem by increasing transparency and accountability in the marketplace for sustainable investments.
But perhaps just as important is the regulation’s potential to encourage more investors to take the critical next steps, such as signing onto the Impact Principles. The rollout of SFDR could emerge as a turning point in the history of sustainable finance – the moment in which a broad swath of the market agrees on what is or isn’t sustainable and gets to work addressing urgent sustainability challenges.