Potential improvements to how investment consultants approach ESG considerations

Our central conclusion is that investment consultants are unlikely to take action on ESG issues without stronger incentives to do so from their asset owner clients.

Our research points to a series of interventions that could be made to fully integrate ESG issues as a standard part of investment consultants’ service delivery.

Market structure

1. Enable small to medium and resource constrained asset owners to pool and clearly express their ESG service demands

The PRI could enable asset owners to work together to send consistent and aligned requests to investment consultants on their expectations of the ESG-related advice they expect to receive.

This could include sharing good practice ESG requirements in contracts and transparency on ESG costs and fees.

2. Support policy interventions to increase pension scheme pooling

The PRI could support policy interventions which increase the pooling of institutions. Larger institutional investors are more likely to build an internal resource and be an alternative source of innovation in ESG investment. A market of larger institutions would be more demanding of consultants and force them to adopt these ideas more quickly.

3. Explore the development of a kitemark

The PRI could explore the development of a kitemark or quality standard for the consultant market with professional bodies or regulators.

Such a kitemark or quality standard would certify that the consultant provides high quality advice on ESG-related issues. An alternative could be an industry benchmark for investment consultants on ESG service delivery.

Investment practice

4. Incorporate ESG in asset owner investment strategies and investment consultant beliefs

The PRI supports asset owners to adopt investment strategies and embed ESG consideration as fundamental investment insight.22 The PRI could support asset owners in asking their consultants to publish their ESG investment beliefs. This would include explanations of how these commitments align with fiduciary duties and of how they manage conflicts of interest.

The PRI could also encourage consultants to report publicly on how these commitments are being implemented in the research and advice they provide to clients. This reporting should include discussion of how the firm is developing its competencies and capacities in responsible investment, and how it is taking account of these in its fee models.

The PRI could work with consultants to develop and promote examples of the positive impact that ESG integration can have on investment returns. This is key if perceptions about ESG materiality and the barriers presented by investment consultants’ views on fiduciary duties are to be addressed.

5. Reframe the objectives, philosophy and composition of service lines

The PRI could set up projects to assist investment consultants develop more advanced ESG integrated services. For example:

Develop a full ESG overlay. This could support clients in understanding the ESG risks and opportunities in their portfolio construction. This could involve extending ESG analysis beyond listed equity to other asset classes, including alternatives and liability matched products. A starting point could involve lengthening the time horizon used to assess investment performance and developing tools to quantify ESG issues.
Start an asset-landscape visioning project. This could be a theoretical project looking to understand how a world without all the norms of investment applying would work – efficient markets, listed investments and universal ownership. Such a project could challenge assumptions that have been identified as holding back more advanced approaches to ESG integration.
Explicitly challenge efficient market hypothesis (EMH) and capital asset pricing model (CAPM) and bias towards past data. Outputs could include papers providing alternatives to the CAPM approach to portfolio construction. This could be best served by coupling the content with factor investing which is currently breaking into the market.

6. Enable asset owners to explicitly account for ESG capabilities when appointing and reappointing investment consultants

The PRI could publish guidance for asset owners on how to identify, select, appoint and monitor investment consultants. This could include suggested questions for due diligence and selection processes, and suggestions on what good practice looks like and measures of performance. It could also include guidance on:

how consultants might be incentivised to build ESG capacity (e.g. through including this as a factor in appointment/reappointment decisions);
how asset owners might use the data and information reported under the PRI reporting and assessment framework.

The PRI could ensure that this guidance is widely distributed through its asset owner network and could actively encourage its uptake. This could form part of the PRI’s wider efforts to encourage asset owners to make commitments to responsible investment and to ensure that these commitments are effectively implemented.

PRI Reporting and Assessment

PRI Reporting and Assessment is the largest global reporting project on responsible investment. It was developed with investors, for investors. Signatories are required to report on their responsible investment activities annually. This ensures:

accountability of the PRI and its signatories;
astandardised transparency tool for signatories’ reporting;
that signatories receive feedback from which to learn and develop.

Investor signatories are assessed against a range of indicators within each module. Transparency Reports are available for public download from the PRI website.

From 2018 all PRI service provider signatories, including investment consultants, will be required to report annually on some of the themes addressed in this paper, such as ESG incorporation in advice, ESG beliefs and how this fits into their perspective on fiduciary duty. The responses to the reporting framework will be available on the PRI Data Portal. This will make service provider reports more accessible to investor signatories, which could contribute to enhanced dialogue between asset owners and investment consultants as well as improved knowledge sharing among investment consultants.

7. Publish minimum requirements on ESG

The PRI could develop proposals on what the key elements of a good basic ESG advisory service looks like, and press for this to be a standard part of all consultants’ offering to their clients. The PRI could provide transparency for asset owners on costs and benefits of more advanced ESG service provision.

8. Develop expertise on ESG issues

The PRI could make available the PRI Academy trustee training course for a reduced cost on the condition that investment consulting firms commit that all field consultants complete the course.

The PRI could support efforts to change market views on ESG issues by making these issues an integral part of professional training in, for example, CFA or actuarial exams. It could also work with these bodies to ensure that ESG issues are an integral part of continuous professional development (CPD) requirements for chartered professionals in these areas.

The PRI could work to ensure that ESG issues are an integral part of the codes of professional ethics such as those adhered to by holders of the CFA and the members of the actuarial professional bodies.

9. Integrate ESG in the client-consultant relationship

The PRI could re-publish or rework its practical guides (e.g. on ESG integration in listed equity and fixed income) to help illustrate and explain what good ESG advice by consultants should look like. The PRI could establish consultant networks for the sharing of case studies and experiences on ESG issues in order to develop best practice.

10. Develop guidance on fiduciary management

The PRI could publish guidance for investment consultants on full ESG incorporation in fiduciary management. This would include applying recommendations made in PRI’s asset class guides to the investment consultant’s fiduciary management business.

Policy and regulation

11. Clarify that asset owners and asset consultants must consider ESG issues in investment processes

The PRI and UNEP FI’s fiduciary duty programme has concluded that failing to consider ESG issues is a failure of fiduciary duty. The programme is engaging regional and national governments to update investment regulation to clarify that fiduciary duties require investment decisionmakers to consider ESG factors in their investment processes, and in the processes of their agents.

This could be extended to investment consultants, such that, as part of their duty of care requirements, they advise asset owners on all financially material risks and opportunities, including ESG issues.

12. Work with professional bodies to incorporate ESG within professional regulation

The PRI could work with professional bodies (such as the CFA and actuarial bodies) to ensure that ESG issues are an integral part of the codes of professional and technical standards adhered to by their members.

13. Support policy interventions to put sustainability at the core of financial regulation

The PRI could support policy makers by use of measurable objectives to articulate the role capital markets should play in contributing to a sustainable financial system. This would include provision for investment consultant-related regulation. In addition, policy makers should:

strengthen policy design – tentative drafting and easy opt-outs mean responsible investment policy is often easy to disregard;
improve monitoring and communicate the impact;
clarify how regulators’ mandates contribute to sustainable economies;
introduce mandatory corporate reporting on ESG issues;
build capacity (people and skills) for monitoring responsible investment implementation.