Hedge funds warn EU on adding ESG into investment rules, calling for better corporate disclosure

AIMA publishes recommendations for regulators on responsible investment

The global body representing hedge funds and direct lenders has today published a report on responsible investment in which it warns regulators that embedding ESG practices into investment rules “may end up being redundant or self-defeating”.
The Alternative Investment Management Association, (AIMA) based in London, represents some 2,000 firms. Speaking to Responsible Investor, AIMA’s CEO, Jack Inglis, said: “Our manager members reported increasing questions about, and demand for, ESG and responsible investment in strategies and portfolios. Requests for more targeted products in this space have risen very substantially over the past two years. So hedge funds have been very highly alerted to the need to address this.”

“Managers are best positioned to know what their investors want from a responsible investment product, and indeed whether their investors want such a product at all.”

AIMA’s work on sustainability (which has seen it set up a dedicated working group of undisclosed “interested participants” from its membership) has also been driven by the regulatory push coming from the European Commission and elsewhere, said Inglis. AIMA submitted a feedback letter on the EU’s plans during the public consultation period, and has had “individual follow-up conversations directly between us and the Commission,” he explained.
Today’s report lays down seven regulatory principles that AIMA believes policymakers should consider when creating rules to strengthen sustainable finance. While some other recommendations made to regulators on this topic by groups such as the EU’s High Level Expert Group on Sustainable Finance focus on concrete solutions and suggestions, AIMA’s report looks mainly at what regulators should not do, and how to support a more ‘hands off’ approach.
The proposals are that regulation should be:

1. Investor-led, with a strong consideration for fiduciary duty. “The implementation of responsible investment should be a product of investor demand,” the authors say. “Managers are best positioned to know what their investors want from a responsible investment product, and indeed whether their investors want such a product at all. It may therefore be unwise to require all investment managers to adopt responsible investment principles.”

2. Principles-based, rather than prescriptive. “Any responsible investment regulation must allow the field to develop naturally and sustainably, and not unduly stifle or constrain it,” the report says.

3. Proportionate. Regulators should “be mindful” that some investment strategies – including short-term sovereign bond trading – have no room for ESG. “It is unnecessary to force managers to have additional disclosures around those strategies – not only does it add work and costs to managers, but it potentially gives rise to greenwashing if managers feel they have to demonstrate at least something when it’s not relevant,” Inglis told RI.4. Non-duplicative. “Regulation that seeks to embed responsible investment practices into various aspects of investment management, such as risk management, may end up being redundant or self-defeating,” says the report. “Managers take their role as guardians of the capital of their investors seriously, and exercise thorough risk management and asset selection processes. These already take into account such things as sustainability risks, where they are material.”

5. Consistent. The report says it is “imperative” that regulators are consistent in the way they define responsible investment across different pieces of regulation, calling for “a common vocabulary which has an appropriate level of flexibility”.

6. Practical. Data on this topic can be “expensive, inconsistent, or simply unobtainable”, according to the report. “Compelling managers to use certain forms of data could create an artificial market in which the managers are forced buyers,” it warns.

7. Broad-based. Creating rules for managers won’t achieve responsible investment objectives on its own, says AIMA, and regulation “must encompass the behaviour of issuers”. “In many jurisdictions, issuers have few obligations when it comes to disclosing ESG data, and a strong incentive not to do so voluntarily.
Any responsible investment regulation should ensure a proper foundation of data is available before mandating specific action on the part of managers,” it urges. Inglis told RI that more stringent rules around corporate disclosure on ESG was “very much the ask that we’re putting forward in this report”. “We think it’s absolutely vital that the European Commission focuses on the issuers of securities, because there is at present a lack of relevant, full disclosures from companies that would enable investment managers in those companies to be wholly confident that they are reporting their ESG risks correctly.”

“It’s not hard to persuade someone that, over the long term, fossil-fuel companies are going to underperform renewable energy companies, so the best way to construct a portfolio should not only be to ‘long’ renewables, but also to short fossil fuels”

He added that the hedge fund industry is “probably better equipped than a traditional asset manager to deliver on these kind of mandates because of their ability to utilise short selling”.
“It’s an increasingly easy argument to construct that short selling can be positive for ESG. It’s not hard to persuade someone that, over the long term, fossil-fuel companies are going to underperform renewable energy companies, and so the best way to construct a portfolio over that timeframe should not only be ‘long’ renewables, but also ‘short’ fossil fuels. And while that’s a gross oversimplification, I think it’s a relatively uncontroversial argument: shorting will be important in sending signals to those companies that need to change – not just by not owning them, but by having a short position in the worst offenders”.