The top five global risks recognised by the World Economic Forum in 2020 share one commonality: they are all related to the environment. Environmental sustainability is no longer an unattainable ideal in the business world. Given the worldwide climate crisis, it has become a matter of significant immediacy. With pressure mounting from investors and regulators alike, asset managers are encouraged to pivot to environmental sustainability by integrating environmental risk management (“ERM”) practices into their business practices.
Guidelines on ERM for asset managers (the “Guidelines”)
In the Guidelines published in December 2020, the Monetary Authority of Singapore (MAS) recognises that the scale, scope, and business models of asset managers and their investment strategies differ markedly. Therefore, adherence to the Guidelines must be commensurate with the size and nature of individual investment activities, as well as the wider investment focus and strategies. Managers which are part of a global group can leverage group governance structures, frameworks and policies to meet the principles in the Guidelines.
Presently, the Guidelines apply to all discretionary licensed and registered fund management companies. Where investment management is delegated to sub-managers or advisors, managers nonetheless retain overall responsibility for ERM and are expected to assess and monitor their sub-managers’ or advisors’ compliance with the Guidelines. The Guidelines do not, for now, apply to non-discretionary managers. While a transition period of 18 months is in place to allow for the implementation of additional measures to comply with the Guidelines, the MAS is set to begin reviewing the implementation progress of certain managers soon.
The Guidelines broadly cover (i) governance and strategy, (ii) research and portfolio construction, (iii) portfolio risk management and (iv) disclosure of environmental risk.
Governance and Strategy
The manager’s board of directors and senior management should oversee the integration of ERM policies into the manager’s investment risk management framework. ERM policies should be disclosed, regularly reviewed, and revised for continual effectiveness. Where environmental risk is deemed material, managers should designate a senior management member or a committee to oversee the management and implementation of the policies to minimise possible oversights.
At the operational level, ERM responsibilities should be clearly delineated as follows:
- Business line staff to consider environmental risks when establishing and managing funds/mandates;
- Risk management and compliance to monitor the implementation of ERM policies and ensure their adherence to applicable rules and regulations; and
- Internal audit function to test the robustness of its ERM framework.
Research and portfolio construction
The Guidelines set a consistent standard for managers to integrate assessment of environmental risk into investment decision-making. Environmental risks should be factored into the evaluation of a potential investment’s returns, while sectors with higher environmental risks should be identified and, one might argue, avoided. Thereafter, managers should evaluate the materiality of such risks. The Guidelines provide useful examples of factors relevant to the consideration of various asset classes, including public equities, fixed income, direct real estate, and REIT investments.
Subsequently, at the portfolio construction stage, managers should measure and assess all environmental risk factors present in a portfolio on an aggregate basis where material.
Portfolio risk management
Developments such as the occurrence of natural disasters and changes in regulations could materially affect the operations and financials of an investee company. To mitigate these adverse impacts, managers should implement appropriate processes and systems to monitor, assess, manage, and respond to potential/actual material environmental risk on individual investments and portfolios on an ongoing basis.
A process and system highlighted in the Guidelines is “scenario analysis” based on forward-looking information and conservative assumptions that are regularly reviewed to assess and quantify the impact of various environmental risks on investments. Each analysis should be properly documented and maintained, including features such as the choice of scenarios, reasonableness of assumptions, assessment of results, considerations on potential action required, and actions taken to address the risk. For smaller managers, the MAS suggests performing scenario analysis at an individual investment level, focusing on sectors more affected by environmental risk before progressing to analysis at the portfolio level.
Another aspect of ongoing ERM is stewardship. Managers are expected to shape corporate behaviour of their investee companies through engagement, proxy voting, and sector collaboration.
The last process highlighted is capacity-building, which equips directors, senior management, and staff with adequate understanding and expertise to manage environmental risk in their respective roles. Capacity-building programmes should be regularly reviewed to incorporate emerging issues relating to ERM.
Disclosure of environmental risk
Managers are expected to make meaningful disclosures regarding their approach to ERM in line with international reporting frameworks. The MAS accepts disclosures via annual reports, sustainability reports, investor reports and/or websites. Managers should evaluate the various means and methodologies of disclosure and adopt an approach and frequency that best enables them to provide clear, meaningful, and timely information to their stakeholders.
The Guidelines usher the beginnings of a new tenet of corporate governance. While helpful ERM resources, frameworks, and policies exist, these do not incorporate all risk areas covered in the Guidelines. Managers should consult their professional advisors to put together a comprehensive ERM policy, taking into account the specific features of their funds/mandates to ensure present and future compliance with the Guidelines. Asset managers who are quick to respond to regulatory changes will find themselves well-positioned to compete in the new realm of investment universe where, as a first, the earth and its wellbeing will take precedence.